The optimistic case for the British economy

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“Grey gloom” is not the front-page headline many Britons would have wanted to read at the start of the new year. But the phrase sums up the economic mood according to the Financial Times’s annual survey of economists. It is easy to see why. The UK economy shrank in the third quarter of last year, putting it on the cusp of a recession. It is expected to grow by about half a per cent in both 2023 and 2024 as the impact of high interest rates and elevated price levels squeeze households and businesses.

Economists are a melancholy bunch. A similarly downbeat outlook this time last year turned out to be overly pessimistic. Inflation fell faster than expected and unemployment did not surge as predicted. Revisions to gross domestic product also showed that Britain’s post-pandemic recovery was in line with G7 peers, and not the worst as previously forecast. Looking ahead, there are a few reasons why the bearish outlook on Britain may weaken.

First, Britain begins 2024 with a more stable policy outlook than in the recent past. That may be a low bar, given the political turmoil since 2016, but in the past year the government has overseen an improvement in the business environment. Ties with the EU have improved, and the UK has rejoined the bloc’s Horizon Europe science and research programme. The full expensing of capital investment was also made permanent in the Autumn Statement. The UK’s capital allowances are now among the most generous in the OECD, and businesses are spending again. Investment has finally jumped above levels before the Brexit referendum.

Line chart of Index (Q1 1997=100) showing UK business investment has rebounded

The UK is also one of the few major economies where an election will be contested this year between two relatively centrist parties, with no far-right party challenging for power. Prime Minister Rishi Sunak has admittedly put vote-grabbing above economic interests in some areas, including policies to slash legal immigration. But both main parties are engaged in reasonably constructive debates on how to boost long-term growth, which includes reforming byzantine planning laws and rethinking whether UK pension funds could invest more effectively. A significant Labour party victory, as polls indicate, also points to continuity in the medium term.

The shift towards calmer waters appeals to investors. The economy could see a decent rebound, particularly if global economic conditions also improve. Just under 50 per cent of executives surveyed by Ernst & Young in June expected the UK’s attractiveness for business to rise in the coming years. Many businesses have now adjusted to costlier EU trading arrangements, and with a lot of negative news priced in, cheap UK stocks could be in for a resurgence in valuation. Real-terms wage growth and steeper than expected cuts to interest rates may also bolster near-term economic activity.

Britain has a number of strengths it can build on too. It retains a comparative advantage in financial and professional services and is unique in having so many world-class universities spread throughout the country — which, alongside its finance sector, helps to draw global talent. London remains the largest hub for start-ups in Europe, which means there is significant scope for job creation and innovation. The UK is also building a specialism in life sciences, advanced manufacturing and renewable technologies. It is already a leader in offshore wind.

Low growth and high rates paint an undeniably downbeat picture for the year ahead. But continued policy stability for businesses, and sensible measures to develop existing advantages and emergent sectors, could mean the “grey gloom” starts to lift.


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