Paul Diggle
Hello and welcome to Macro Bytes the economics and politics podcast from abrdn. My name is Paul Diggle, Chief Economist at abrdn.
Luke Bartholomew
And I'm Luke Bartholomew, Senior Economist at abrdn.
Paul Diggle
And Macro Bytes is back from its summer break and we're kicking off with a dive into the state of the UK economy and politics. Now the UK is being called ‘stagflation nation’ with a growth and inflation performance that's been disappointing among its developed market peers. The very latest inflation data has improved a little and that's allowed the Bank of England to shift back to smaller 25 basis point rate hike increments. And meanwhile, it looks like a pretty close-run thing whether the Prime Minister, Rishi Sunak is going to meet his pledge to halve inflation. So, to discuss the outlook for the UK economy and politics, Luke and I are joined by Lizzy Galbraith, Political Economist at abrdn. Hey, Lizzy.
Lizzy Galbraith
Hi Paul.
Paul Diggle
So Luke let's start by me posing you a question, which is to set the scene on the UK’s growth and inflation performance. You know, what's UK GDP been doing? What's CPI inflation been doing in the UK recently?
Luke Bartholomew
Well, to set the scene a little bit more perhaps it's worth saying that we're recording today on Tuesday, the 8th of August, and we're due to get on Friday this week, Q2 GDP data out of the UK. And that report is likely to show that the economy at best stagnated and probably even contracted through the second quarter. So just looking at that number alone, it doesn't look too spectacular. However, I think it's important not to read too much just into that one GDP number. There are some idiosyncratic things going on there. So there's the extra bank holiday in May around the king's coronation, and also elevated industrial action, which means that it's not really giving us a true underlying sense of how the economy is doing there to see that contraction. And equally, we might probably see a bit of rebound in the third quarter as those factors unwind a bit. And in fact, if you look through the last year or so of GDP data, I mean, that has been this consistent trend of it being bounced around a bit by these various one-off funnies. But looking through all that noise, I think the clear trend is really one of stagnation the UK economy has barely grown in the last year or so. And there is one way of looking at that which is actually maybe that stagnation is not as bad as it could have been in the sense that we've had this huge increase in energy prices. Real incomes have been eroded by a high inflation, monetary policy has tightened significantly. And in that context, many people were talking about the UK economy likely to be in recession already. And of course, we've avoided that worse outcome. However, I do think it's probably a little bit early to feel like we're out of the woods yet. There have been some quite important changes in the way the UK mortgage market works. There are a lot more fixed-rate mortgages compared to the past. I think what that means is that the transmission of that tighter monetary policy, the high interest rates from the Bank of England hasn't really started to hit the economy with earnest till about now. I think the impact of that tightening is only really starting to come through at this point. And indeed you are starting to see in the incoming data, there are pretty clear signs of a more sustained slowdown. The survey data has been suggesting that manufacturing has been in contraction for some time. But it now looks like the services sector is also slowing very sharply. Retail sales have been weaker, cracks are appearing at last in the labour market and property prices are starting to fall. And we'd expect all of those trends to accelerate through the second half of this year as that monetary policy tightening continues to come through. So I think it is pretty difficult at this juncture to see how the UK does avoid a recession.
Paul Diggle
So that's the growth picture - sideways to down. What about inflation?
Luke Bartholomew
So we started the year with inflation just above 10%. And inflation was always going to fall quite significantly this year due to some very big base effects. So the comparison from last year. But the disappointment has been that inflation isn't falling nearly as quickly as many hoped and expected. So we have had those energy base effects coming through and we'll continue to do so. But food price growth has been much higher and then just more generally underlying inflation pressures have been stronger. Now, as you alluded to at the start there, the most recent inflation data has been a bit better. We're now sub 8%. And the next inflation report is also likely to show another big fall in headline inflation, due to a fall in energy prices. So we could see something like a high 6% number coming out in the next print. And I think there are good reasons to think that inflation probably now will fall below 5% by the end of the year. But still the underlying inflation picture, even if that headline number’s, perhaps looking a little bit better than it did a few months ago, the underlying stuff is very challenging. Core inflation is elevated and there are signs that the UK has something like a wage-price spiral dynamic developing, or at the very least, is at a high risk of one. Wage growth is running well above anything like a target consistent level for the Bank of England. And I think that probably is its biggest concern at the moment.
Paul Diggle
And let's talk about how that stands in an international context then. Because inflation has always been a problem everywhere, there have been challenges around growth in many economies. So is the UK a particular outlier? Financial markets of course have at times priced the UK as a very big stagflationary outlier. Is that fair? And what's idiosyncratic about the UK?
Luke Bartholomew
So fundamentally, I think the UK’s problem has been that it sort of got the worst of both worlds in terms of the shocks or the problems facing both the eurozone and the US. So, it has the very big energy price shock that the eurozone has had, but it has also had the extremely tight labour markets and therefore, upward pressure on wage growth, the possibility of these wage price-spiral dynamics developing that the US has had. And more than that, the US’s very tight labour market is, to a large degree, to do with the fact that demand for labour has been very strong. There was a lot of stimulus in the US, which has kept the US economy and its recovery very solid. Whereas the tight labour market in the UK feels much more like a constrained supply story that labour supply has been much weaker in the UK. So labour markets are tight, less so because demand is incredibly strong, but more that we're struggling to find the supply to meet what demand there is. And there's a couple of reasons for that constrained supply, labour supply, I think. Firstly, we're looking at very elevated long-term sickness as a consequence of NHS waiting lists being so long, partly to do with childcare costs being so high, the UK is notorious for having extremely high childcare costs compared to the developed world. It's partly a story of early retirement from the pandemic.
Paul Diggle
And why would that be a UK specific factor Luke? Why more early retirement here than elsewhere?
Luke Bartholomew
Yeah, it's a good question. And there aren't any obvious standout answers, I think part of it might be to do with the structure of housing wealth in the UK that is disproportionately held by older parts of the population. I think partly to do with the fact that the way the triple lock, the government's way in which it protects pensions, has kept real-term payments for pensioners quite high. And it could also just be a temporary thing that we could see that high inflation plus falling asset prices, falling property prices, ends up just eroding the wealth that many people were hoping and expecting to be able to retire on. And so they end up being forced to return to the labour market. So that could indeed reverse in time. And then the other aspect is around migration and less so absolute levels of migration. In fact, those kind of numbers have been very high recently. It's more of a question of the difficulty that firms and sectors in particular have had in bringing in workers from the EU during periods of shortages. So exacerbating shortages in particular sectors of the labour market. So this very negative supply backdrop explains why UK activity growth has been so poor, but inflation has been so high. That being said, in this international comparison, I mean, there is a slightly unfair comparison that comes in just looking at a headline inflation data in the UK and comparing it say, with the Eurozone, and that's to do with the way in which wholesale energy prices are passed through to households in the UK. So in the Eurozone, it tends to be that wholesale prices go more directly into bills so you get this much quicker pass-through from what's happening in energy markets to what households pay and therefore inflation and so as energy prices fell significantly this year, you saw that almost immediately translated into European inflation whereas in the UK, it's all mediated via the OFGEM price cap and that has to be reset periodically. And so we have to wait for that reset to happen before we feel the effects on household bills, and so inflation. And indeed, we should see those effects coming through quite strongly in the second half of the year pulling UK inflation down. But for now, it's sort of been, quote unquote, ‘artificially’ kept a bit higher just because of that mechanism. That being said, the UK’s core inflation picture is, I think, pretty clearly worse. It’s hard to see what the artificial thing that could be distorting that is, and I think that's part of the reason why the Bank of England probably has more work to do in terms of tightening monetary policy, compared to say the Fed or the European Central Bank where more likely than not those guys are probably done in terms of their tightening. And then on the activity side, I mean, the UK is clearly in a worse position than say, the US which has grown relatively strongly the last couple of years. Compared to the Eurozone, maybe the comparison isn't so worse, in particular likes of Germany, which has been extremely weak. And if anything, it is possible that the Eurozone finds itself in recession a bit earlier than the UK. But still, you know, it's not much of a comparison, when it's just a case of falling into recession one quarter, perhaps later than the other. It's in both cases, a pretty poor growth outcome. So maybe, Lizzie, this is actually a good time to bring you into the conversation. With that economic backdrop, I'd be interested to know what you think it means for the politics. And in particular, we've talked before about the Prime Minister's pledges of which some have quite significant economic content. Part of what I was saying there suggests that maybe the Prime Minister can feel quite optimistic finally, that the inflation pledge will be met - but maybe ones around growth look a little bit more challenging. So what are your thoughts on what the impact would be if the Prime Minister were to fail to meet these pledges?
Lizzy Galbraith
Yeah, so at the start of the year, Sunak, set out five pledges that are essentially his targets for 2023 as a way of essentially signalling to voters that this was going to be a government that was clear in its communication and accountable on its policymaking. So just as a quick recap, those five pledges were to halve inflation, to grow the economy, to get national debt falling, reducing NHS waiting lists and passing legislation to stop small boats crossing the English Channel. Obviously, quite a lot of these are fairly vague in terms of how they were defined. That was somewhat deliberate, but they do all tie very strongly to the issues that voters say matter most of them. So this is a really key part of Sunak’s pre-election positioning. And as you said before, they also tie pretty closely to the big issues that face the UK economy as well. There's risk and reward in the approach that Sunak has taken. As you've said, the inflation pledges may be looking a little bit more achievable now. Inflation was about 10.7% when that target was set, so getting inflation back to around 5% would be that box ticked. However, Sunak has essentially tied himself to some policies and some pledges that just aren't really in his gift to influence, particularly strongly - particularly this growth target, which isn't particularly well defined, but as you've said, is looking pretty far out of grasp at the moment. There's also an issue here with just the way that voters have interpreted these pledges. So polling data shows that that inflation pledge in particular, has been misinterpreted by a majority of voters. Most people when they're polled believe that getting inflation falling, it means that they're going to see prices either stay the same or fall by the end of 2023. So even if we do see Sunak meet that inflation pledge, it's actually not looking like voters are really going to reward him for that, because he still won't have met their expectations for what they think that pledge means. And similarly, the only one of the five pledges that we're currently seeing being met is passing of legislation to stop small boats. Passing legislation in of itself is unlikely to be rewarded by voters unless we start to see a material drop in the number of small boats crossing the Channel. So although Sunak may be able to meet some of these pledges, with maybe the growth pledge, and the NHS waiting lists pledge remaining far out of reach, even those ones that he can meet, voters are unlikely to really react positively to that and these pledges might end up being a bit more of a hindrance than a help as the year closes out and both parties move more into election campaigning territory.
Paul Diggle
Yeah, the irony of course is that some of those targets, especially lowering inflation had seemed like they were gonna be very easy to meet at the time. And it's turned out to be much more difficult and also not really in Sunak’s gift, because the primary lever to control inflation is, of course, independent monetary policy, not what the government does. But let's talk then about what polling is saying ahead of the 2024 UK General Election. You know, in this context of a difficult economic backdrop, what are the polls doing? What are our expectations in the run-up to the general election next year?
Lizzy Galbraith
So, Labour's had a pretty substantial and consistent lead in the polls now, for over a year. It's currently got a lead polling average of around about 20 points above the Conservatives. This is substantial. It's quite likely that it will narrow somewhat before the next election, but it is nonetheless really quite a large lead. And the consistency of it also speaks to a pretty solid base case that we hold of Labour being the largest party at the next general election. And we do say largest party rather than majority government, because it is important to remember that labour does have an enormous electoral hill to climb, if it does want to enter number 10. So while we do see this very large polling lead, Labour do only hold just over 200 seats, and they do have a very long way to go to gain a majority. There are some interesting things once you look under the headline polling data that emerge though. So when you look at Starmer and Sunak’s approval ratings, Starmer is actually around about 20 points ahead of Sunak in head to head approval ratings, but they're both still actually in negative territory. So, we're not seeing you know, a particularly strong enthusiasm for Starmer or for Labour. This is actually more about voter frustration with the Conservatives than it is around a sort of a massive swing towards Labour. And you can see that in some of the recent by-election results as well. A lot of the big swings that we saw in Selby, and in Somerton were 20,000 Conservative majorities were overturned by Labour and the Lib Dems. It wasn't about voters actually switching to those parties that won those seats. It was about the Conservative vote dropping really substantially and then those voters staying at home. Now, you can't read too much into by-elections. There were particular reasons for voter frustration to play a part in what happened in those seats. And, you know, a 20,000 votes drop is not a replicable thing across the country in every seat. However, I think it is indicative of this, this pattern that's developing of really voter frustration with the Conservatives actually driving some of the polling changes that we're seeing. And yes, Labour can take advantage of that but it is important to note as we move closer to the election, and the polls start to narrow.
Paul Diggle
abrdn is obviously an Edinburgh headquartered company, Lizzy, so are there any interesting things going on with polling for the general election in Scotland in particular?
Lizzy Galbraith
Yes, there is. Labour believe that for the first time since the sort of big collapse of its vote share in Scotland in 2015, that there's a real chance of meaningful seat gains in Scotland. So Labour are obviously at a historic low, in terms of the number of seats they hold in Scotland. They currently only hold one. But we're seeing a bit of a change in the polls in Scotland. Labour are gaining ground on the SNP here, although the SNP still lead in the polls, that lead is narrowing quite significantly. And that's partially driven just by this general national increase in Labour's polling numbers, but it's also driven by factors specific to Scotland, particularly the internal issues that the SNP is facing that are driving voter discontent with that party. We're going to see a test of whether Labour can turn around its fortunes in Scotland relatively soon. There will be a by-election in Scotland in the autumn and Labour will be hoping to retake that seat. They lost it to the SNP in 2010. And the majority there is around about 5000. So it does seem like this is going to be a very important test for Labour and it will be a very closely watched result. There will be a lot of seats that Labour will be targeting in Scotland. I think the reasonable expectation would be that they’ll be looking to gain at least 10 and it will be an important part of their electoral strategy as they as they move towards the election. So, I'd expect a lot of time spent in Scotland by the shadow cabinet, a lot of specific policy talking points that reference Scotland ahead of the election. And as well, we may see some, maybe disagreement between Scottish Labour and the Westminster Labour Party, as we've seen over the two-child benefit cap as well. So, there is scope for, for some differences in policy as Scottish Labour start to position themselves for the election to try and take some seats off the SNP and the Conservatives in Scotland.
Luke Bartholomew
So one other area where we might be starting to see some areas where the parties are trying to differ on policy and in particular, given those large polling gaps you talked about and the by-election results, and that's around, seems to me at least something of a fraying in the green consensus in UK politics with the Conservative government and the party more generally becoming a bit more sceptical, perhaps of some of the policies that are associated with that agenda. So how big a potential dividing line do you see that being at the next general election? And also, how significant might it be for the shaping of UK energy policy both in the near term but also slightly longer term as well?
Lizzy Galbraith
Yeah, so this debate was really kicked off when Labour failed to win the seat of Uxbridge in the three recent by-elections that were held. It's Boris Johnson's old seat, it's just outside London, and a particular local issue there was the forthcoming expansion of London's Ultra Low Emission Zone, which was really strongly opposed by voters in that constituency and the Conservative candidate that won in that seat directly attributed the voter backlash to the ULEZ as the reason for his victory. It was a very narrow margin of victory for what it's worth. So Labour did still make a pretty substantial increase in its vote share in that seat. But nonetheless, the Conservatives did retain it. And this then led to a broader debate over the green consensus in the Conservative Party and whether or not the British voters were actually as pro-decarbonisation and the policies that it requires, as we've had previously thought. Since then, the government's made a number of announcements that would fit with a slightly changing strategy on green policy. So we've had the announcement of new oil and gas exploration licences, funding for carbon capture clusters, and a review of taxation of oil and gas companies in the North Sea as well. This has generated an awful lot of media coverage, an awful lot of debate on both sides of the political spectrum, and it did quite usefully for the Conservatives distract from coverage of those by-election results, which were significantly less positive for the Conservatives outside of Uxbridge. Realistically, a lot of the policies that were announced are actually about rhetorical positioning. Post Uxbridge, the Conservatives have seen an opportunity to be able to position themselves as the party that's more alive to the concerns about the costs of net zero. Labour have been more vocal in trying to present decarbonisation and the energy transition as an economic opportunity, rather than something that needs to be carefully managed to avoid putting costs on to the public. But really, we're not actually seeing too much that's either new from the conservative announcements, or anything that amounts to a particular change of direction. So the carbon capture announcements had already been trailed back in March, as had the £20 billion funding announcement that came with them. And we haven't actually seen any more details on how that funding will be delivered in the recent announcements either. Similarly, the oil and gas exploration licences were actually supposed to begin being released last quarter, it had been pushed back to this October. So we were already expecting that announcement to be made, and it was actually late. So we're not seeing a big pivot in the government's policy. What we are seeing is a significant change in its messaging. And it's identified this as an area where it can put some clear water between it and Labour's policy ahead of the next election. So yes, I would expect this to be an election issue. But I think this is actually more about messaging than it is around, you know, a big U-turn in Conservative policy on climate. Nonetheless, I think this debate will continue to rumble on in the Conservative Party and there is certainly scope for it to snowball going forward. But in terms of this government and its climate commitments, I don't think we're going to see them move away from the headline 2030 or 2050 targets. They continue to be enshrined in UK law and also in the Trade and Cooperation Agreement with the EU. So while we're going to see some differences in messaging, some election positioning that would imply a big dividing line with Labour on this, I think that really we're seeing a bit of a slower burn approach to moving the dividing line on climate in the Conservative Party.
Luke Bartholomew
So we will have much more to say in due course, about what a putative Labour government would mean both for energy policy but across the whole policy spectrum, as well. But I think for now, that is all we have time for this week. So as ever, please do let me remind you all to like and subscribe to us on your preferred podcast platform. And then all that remains is for me to thank Lizzy for joining us today. And also to thank you all for listening. So thanks very much and speak again soon.
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