Britain’s economy might spring a surprise on the doomsayers this year

The UK economy is looking pretty good – we’re more at risk of a boom than a bust, says John Stepek. Here’s why, and what it means for your portfolio.

We’re into February now. We’re starting to get economic data that covers the post-election period. So how’s the UK economy doing now that the political situation is a tiny bit less uncertain?

Let’s start with this week’s data. Yesterday, UK inflation came in significantly higher than expected. Consumer prices index inflation (CPI – the official Bank of England target measure) rose by 1.8% year on year in January. That’s still below the Bank’s 2% target, but it was quite a leap from the 1.3% seen in December.

Meanwhile, inflation according to RPIX (the retail price index excluding mortgage interest costs) rose at an annual rate of 2.8%. RPIX used to be the Bank’s target measure – back then, the target was 2.5%, so we’re above target now.

It’s a good thing they don’t use that measure anymore, eh? (My colleague Merryn explains what the difference is between the two here).

The economic data for the UK has been pretty decent

The good news is that wage inflation continues to outstrip price inflation. Earlier in the week, we learned that average weekly wages in the UK rose by 3.2% year-on-year (excluding bonuses) in the three months to December.

That’s a slowdown compared to previous months, but it’s still a healthy clip. And given that employment is currently so high, you have to think that there will be increasing pressure on wages to rise.

Meanwhile, other data suggests that Britain is indeed enjoying a post-election economic bounce, offsetting the weak ending to 2019. No, I’m not talking about the news that house prices are rising which, despite the various “Brexit bounce” headlines, is actually based on official data that pre-dates the election.

Instead, I’m talking about retail sales. Data released this morning was much better than expected (and a lot better than all the “the end of the high street” headlines would have you believe). Retail sales volumes rose by 0.9% month-on-month, which was ahead of the 0.7% analysts had expected. And excluding petrol sales (which don’t necessarily tell us much about appetite to spend), sales were up 1.6% on a monthly basis, the biggest rise since May 2018.

So, for the time being, this is all pretty healthy looking. At these levels and these rates of change, neither price inflation nor wage inflation are going to cause the Bank many sleepless nights. Central bankers across the globe want inflation to be higher, so the fact that the UK is not at risk of deflation will be the main thing as far as the Bank is concerned.

Don’t be surprised if money gets even looser from here

It does, however, suggest that more interest rate cuts are going to be very hard to justify. Which is quite a change when you think about it, given that the market was until very recently almost convinced that there would be a cut last month.

Not that rate cuts by the Bank particularly matter at this point. I think you could argue that the biggest economic effect that cutting rates has in the UK is to make mortgages cheaper. When you make mortgages cheaper for people with variable rate mortgages, it’s like a tax cut – they end up with more money in their pockets.

This is less of a stimulus at the moment, because lots of people have fixed-rate mortgages. But there are other ways in which lower rates boost sentiment and spending power. When you make mortgages cheaper, you make houses more expensive (if you can borrow more, you’ll pay more).

If houses become more expensive, people feel more relaxed about the state of their personal balance sheets. When that happens, they spend more. They might even borrow more against the perceived value of their homes. This is what economists describe as the “wealth effect” (in the US, the stockmarket is more a driver of the wealth effect – here it’s houses).

So what’s my point?

Well, you don’t need the Bank to cut rates to make mortgages cheaper. You just need to create conditions in which high street banks and other lenders feel the need to compete to attract customers for mortgage loans.

When banks compete with each other to lend, two things happen. The cost of borrowing goes down, with banks taking the pain in their profit margins. And the stringency of credit checks is loosened, with banks looking for reasons to say “yes” rather than “no”.

It looks as though we’re getting into this territory now. Lloyds Banking Group (in which I own shares, I hasten to add) reported its results this morning. In among all the other stuff (such as finally drawing a line under PPI compensation), the bank warned – and I quote the FT here – “that its ability to make money this year will be constrained by fierce competition in the mortgage market”.

If you want to know why house prices are perking up again, this is what you should blame – not a “Brexit” or “Bojo” bounce.

What does it all mean?

Put aside all your political convictions for a moment. Everyone has been worrying about a bust. The risk is that we get a boom instead. Just bear that in mind when you’re looking at your asset allocation.

Recommended

Hong Kong’s crown slips as Singapore takes over
Asian economy

Hong Kong’s crown slips as Singapore takes over

As international sentiment sours on Hong Kong, other Asian financial hubs – primarily Singapore – are snapping up business.
6 Jul 2022
Price of gas soars as Moscow turns off the taps
Gas

Price of gas soars as Moscow turns off the taps

As Russia cuts its gas exports to the EU, the price of natural gas continues to rise. Restricted supplies could see energy rationing and recession i…
6 Jul 2022
Low growth and high inflation: a toxic cocktail for anxious markets
Stockmarkets

Low growth and high inflation: a toxic cocktail for anxious markets

Low growth, high inflation, central bank tightening, a strong dollar, and the risk of recession is proving a toxic cocktail for world stockmarkets – a…
6 Jul 2022
How to cut the cost of childcare
Personal finance

How to cut the cost of childcare

Childcare is expensive, yet few people are drawing upon all the government support they are entitled to. Ruth Jackson-Kirby explains what help is avai…
6 Jul 2022

Most Popular

Ray Dalio’s shrewd $10bn bet on the collapse of European stocks
European stockmarkets

Ray Dalio’s shrewd $10bn bet on the collapse of European stocks

Ray Dalio’s Bridgewater hedge fund is putting its money on a collapse in European stocks. It’s likely to pay off, says Matthew Lynn.
3 Jul 2022
Persimmon yields 12.3%, but can you trust the company to deliver?
Share tips

Persimmon yields 12.3%, but can you trust the company to deliver?

With a dividend yield of 12.3%, Persimmon looks like a highly attractive prospect for income investors. But that sort of yield can also indicate compa…
1 Jul 2022
Is inflation about to drop as recession takes hold?
UK Economy

Is inflation about to drop as recession takes hold?

Central banks are raising interest rates in an attempt to curb soaring inflation. But will that push the economy into recession? John Stepek looks at …
5 Jul 2022