There are some notable reasons for near-term reasons for optimism in the UK. The housing market seems to be picking up, industrial production growth is looking up together with PMI data and the equity market has done well. All these are real and significant signs of a better economy in the UK, but the structural challenges remain.
In particular the specter of stagflation continues to squeeze the overall economy. Inflation remains sticky, impacting real wages and thus final demand. In addition, long term unemployment is still high.
The unemployment rate has fallen (to 7.7%) in the UK and, unlike the US, this has not been due to a fall in the labour participation rate. However, many of the jobs created have been part time, and the average duration of the unemployed continues to climb higher.
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This gives a more realistic outlook for the final demand picture, essential for any long-lived recovery in the UK. When one factors in falling real wages, which have been contracting for most of the last 5 years, it is hard to be optimistic for the UK’s long-term prospects. With public sector workers accounting for just under a fifth of the UK workforce, the slump in the real public sector wage is alarming.
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Inflation is not expected to decline substantially, easing the pressure on real wages, any time soon either. Higher inflation and some improvement in the current economic outlook will pressure the BoE into raising rates. They are making some noises here but we believe they will not act as soon as the market is beginning to think.
The housing market is still chronically dependent on low rates, and higher rates will trigger a wave of repossessions, price falls, deterioration in bank balance sheets, and a slump in consumer demand.
In other words, the patient is still very much dependent on the extraordinarily strong dose of monetary medicine currently being administered.
