The UK is Bouncing Back!

"We're Heading in The Right Direction"

It’s been a roller-coaster year for the UK economy - from battling record-high mortgage rates to falling into a very brief recession, it’s been a bumpy road but the light at the end of the tunnel seems bright.

As we close off Q2, our economy appears to be in good shape heading into the final two quarters of the year. Inflation has come down to the Bank of England’s 2% target, and the country’s GDP (Gross Domestic Product) is on the rise.

Of course, there’s still some ways to go before we return to full prosperity but we’re taking good steps forward. This week we discuss the current strength of the UK economy, how we compare to our peers (the USA and EU), and what next potential hurdles await us.

Let’s dive in.

From Strength to Strength

Inflation has been the key focus for most markets and investors over the past two years and central banks have been on the mission to get it back down to their 2% target.

On Wednesday 19th June, we had the latest UK CPI (Consumer Price Index - the measure of inflation) report and the good news was declared; inflation has finally reached the long-awaited 2% target!

Why is it important to have inflation at 2%?

Economic Stability: A 2% inflation rate helps keep the economy steady, avoiding the problems caused by high inflation (prices rising too fast) or deflation (prices falling).

Predictability: It allows businesses and consumers to plan better for the future, knowing prices will change slowly and steadily.

Interest Rate Management: It gives central banks like the Bank of England room to adjust interest rates to help the economy during tough times.        

Out of the three major economies, the UK is the first to reach this target and is a milestone worth celebrating as the BoE can now confidently look to start cutting interest rates.

A reduction in interest rates reduces the cost of borrowing and tends to signal the beginning of economic growth by allowing a central bank to increase the flow of money into the economy.

Think back to when I explained the economic cycle , we could be seeing the “Trough” stage playing out, where after the period of decline and slow growth, things can start picking up again.

Aside from the lowering of inflation, one of the most important metrics to recognise a growing economy is its GDP number, and from the latest report of our GDP Growth Rate we can see a clear rise:

• UK GDP Growth Rate QoQ (Source )

With the UK’s GDP rising (the strongest growth last quarter out of the other G7 nations), the previously feared recession is now in the rearview and is no longer a cause for concern.

Furthermore, another sign of the UK’s strength is the spending of the consumer, shown by the Retail Sales report data:

• UK Retail Sales MoM (Source )

Consumers are the backbone of an economy and when they are spending, money is circulating and aiding the country’s growth.

So we have lower inflation, rising GDP and rising spending - a completely different picture from last year when the UK seemed to be weak, but now the tables are quickly turning.

Comparison With Our Peers

Looking at our neighbours across the waters, their economic scenarios are a bit different.

Firstly, when we compare the current inflation levels they’re yet to reach the 2% target:

• USA - 3.3%
• EU - 2.6%

The US are the furthest away from the target and this can be attributed to the strong growth their economy was showing in the earlier parts of this year. Although it’s good for an economy to be growing, this was a hinderance in their inflation battle and is evident in their struggle to break below the 3% range.

Growth = More Spending = Higher Inflation        

Nonetheless, recent data reports are showing a slowing of the US economy which should help them in bringing their inflation numbers lower and allow the Federal Reserve to cut rates later this Autumn. Some of these data points include:

• US Unemployment Rate (Source )
• US GDP (Source )

Whilst inflation is elevated the Fed will be in no rush to cut rates just yet but with a declining economy, they won’t hold out for too long as that could damage things further. Hence why most investors and economists predict their first cut will come during the next meeting in September.

Interestingly, the ECB (European Central Bank) has been the first major central bank to cut its interest rates regardless of inflation not hitting the 2% target and this is likely due to the declining growth in their top two major economies - Germany and France.

The ECB understood that although inflation wasn’t where they wanted it to be, it was good enough and couldn't afford to risk their staple countries taking a further hit. So they’ve reduced their interest rate from 4.5% to 4.25%.

With that being said, this rate cut will likely not be followed by another until the ECB see the overall European Union inflation continue into a downward trend as too many cuts runs the risk of devaluaing the Euro currency against other currencies such as the US Dollar - Interest Rate Differential .

What Next?

As the BoE has managed to reach the 2% inflation target, there’s no reason to hold back on cutting interest rates. The next MPC (Monetary Policy Committee ) meeting for the rate decision will be in August, so investors expect to see a cut from the current 5.25% to at least 5%.

It’s important to note that although everything is looking rosey and the economy is bouncing back, the BoE can’t get ahead of themselves and act like the job is done. Yes, inflation is down to where it needs to be, but getting it down and keeping it down are two different things.

With a growing economy, a risk of stoking inflation once more is on the cards so we have to remain cautious.        

The most imminent major event for the UK is of course the General Election on Thursday 4th July. I’m not particularly keen on putting a lot of focus or attention into politics, but we may see some fluctuations in the GBP value during the elections.

This will be short-lived and although the winner and their mandate may dictate new fiscal policy for the UK, as an investor or trader, it isn’t likely to change the bigger picture. The focus for the rest of the year will remain on inflation and interest rate decisions by the central bank.

Fiscal policy is a way for the government to influence the economy by adjusting its spending levels and tax rates

Key Takeaways For You This Week

• Inflation in the UK has finally reached the UK’s 2% target, a milestone that allows the Bank of England to consider cutting interest rates and support further economic growth already shown by rising GDP and retail sales data reports.
• The US and EU are still above their 2% inflation target, with the US at 3.3% and the EU at 2.6%, and while the US economy's strong growth earlier this year has slowed, aiding in their inflation battle, the ECB has already cut rates despite not hitting the target, due to declining growth in Germany and France.
• With the BoE reaching the 2% inflation target, there's an expectation of an interest rate cut at the next MPC meeting in August, but they still need to be cautious to avoid rekindling inflation, especially with the growing economy.

I hope you’ve learned something new, and if you have any questions or want anything to be clarified, please leave a comment below and make sure to follow us on all social media pages.

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