Weekly Update - 2024: A pivotal year for the UK?

2024 is a pivotal year for the United Kingdom. Firstly, similar to the euro area, the economy seems to be bouncing back after two years of near-zero growth, while inflation is falling, which should allow the Bank of England to cut interest rates for the first time since the pandemic. The UK equity markets could therefore continue to perform well, after a sluggish 2023. Finally, the general election to be held on 4 July is expected to end the Conservative party's 14 years in power, with the Labour party taking over.
 
Economic stagnation since the end of 2021. The UK economy has clearly underperformed its peers, including the euro area countries, since the start of the pandemic. Several factors have weighed on growth. Firstly, the UK was one of the country’s most negatively impacted by the health restrictions (posting a 10.4% drop in 2020, the second biggest drop in GDP growth among OECD countries). Pre-Covid GDP levels were not restored until the end of 2021.
Subsequently, in addition to global supply chain disruptions and gas prices soaring linked to the war in Ukraine, the recovery has been disrupted by Brexit, with uncertainties over the regulatory environment as well as new trade barriers and border controls. As a result, between the end of 2021 and the end of 2023, the level of British GDP had hardly risen at all, compared with an increase of almost 2% in the euro area and more than 3.5% in the United States.
 
A recent reversal in this trend. Since the start of 2024, the situation has changed: GDP growth reached 0.6% q/q in the first quarter, driven by a strong rebound in domestic demand (consumption and investment) - compared with 0.3% in the euro area and in the United States. This economic improvement should continue, with the fall in inflation (and the expected fall in interest rates) supporting household disposable income.
 
Moderate fall in inflation to allow Bank of England (BoE) rate cuts. After consistently (and sharply) outperforming its peers, UK inflation has slowed markedly in recent months, to 2.3% year-on-year in April, on a par with the euro area and well below US inflation. Nevertheless, core inflation remains high (3.9% year-on-year), mainly due to service prices. So, although close to target, UK inflation continues to show signs of strain. As a result, the markets have revised their expectations of a rate cut for the 20 June meeting (from a 60% probability before the inflation data release to just 5% since), especially as this meeting will only take place two weeks before the election. However, the BoE should be able to start cutting rates as early as August. Indeed, tensions on the labour market have begun to ease: job creation has fallen over the last three months and wage growth is moderating.
 
An uneventful election campaign? The Conservative Prime Minister has announced that elections will be held on 4 July. The polls give the Labour Party a lead of more than 20 points. Although it was at the heart of the previous election, Brexit is absent from this campaign, which for the moment is focusing on the state of public services (the NHS in particular) and on how to finance their improvement. In any case, the government that will emerge from the election will continue to be constrained by limited budgetary room for manoeuvre.

In the highlights of the week, we chose to talk about  inflation data in the euro area as well as inflation in the United States:
 
Euro area inflation rebounded slightly more strongly than the markets expected in May, to 2.6% year-on-year, compared with 2.5% expected after 2.4% in April. The acceleration was reflected in core inflation, which came out at 2.9% year-on-year, compared with 2.8% expected by the consensus. At national level, harmonised inflation rose to 2.7% in France against expectations of 2.6%, and to 2.8% in Germany. This surge in inflation was caused by both a rise in energy prices and a rebound in services inflation. These data should not call into question the ECB's expected rate cut next week but, in line with our expectations, limits the ECB's scope for aggressive rate cuts thereafter.
 
The consumer price deflator (PCE index), the measure of inflation most closely followed by the Fed, came in below expectations for April, rising by 0.2% over the month against expectations of 0.3%. However, the measure shows that inflation remains rigid in line with expectations, at 2.7% year-on-year in total terms and 2.8% in underlying terms, the same level as the previous month. On the consumer side, personal spending slowed, as did incomes, to 0.2% and 0.3% respectively, reflecting weakening inflationary pressures. These figures attest to the slow decline in US inflation, and are in line with our scenario of a Fed rate cut later this year.

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