A slow recovery

3rd October 2023
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The UK has been hit by multiple shocks in recent years and the fall-out has been felt by businesses and consumers alike. Now, however, there are signs of improvement, as Sunday Times Economics Editor, David Smith, explained at CIL’s 17th Annual Economic Update.


The Four Horsemen of the Apocalypse are disturbing figures – and intentionally so. Representing death, famine, war and conquest, they refer to a period of devastation and destitution, a prelude to the Day of Judgement.

Yet this was the image that Smith chose to underline just how much our economy has been pummelled in recent years. His choice packed a punch. And it was meant to. First, there was the global financial crisis, then Brexit and the Trump trade wars, then the pandemic and then the Russian invasion of Ukraine. Each of these shocks, Smith explained, has had consequences. Some were immediate, others more prolonged but none can be discounted when we look at the economy today.

The financial crisis hit productivity, which grew by around 2% a year for decades and is now stagnating. Productivity is the most important economic indicator, Smith says, driving living standards, prosperity and competitiveness. It has barely moved in 15 years and growth, which averaged 2.7% per annum between 1945 and 2008, has since fallen to an annual average of 1.7%.

Brexit hit sterling and business investment, which was never a UK strong point and remains a problem that no policymaker seems able to tackle.  The pandemic fuelled government debt, resulting in the highest tax burden since World War Two. And Russia’s invasion of Ukraine exacerbated the cost of living crisis and led to soaring inflation, prompting 14 successive increases in the base rate.

Where next?

Against this unpromising backdrop, Smith posed three key questions:

  • Have we avoided recession and what are the prospects for recovery?
  • Have we passed peak inflation and how fast will it fall?
  • Have interest rates peaked and, if so, when will they fall?

As Smith admitted, prospects are uncertain. Global growth is likely to be lacklustre and advanced economies will be particularly subdued, according to the International Monetary Fund. UK forecasts are less attractive than most, with the OECD pencilling in 0.3% growth for this year and 0.8% next.

And yet…. all is not doom and gloom. There is light at the end of the tunnel, particularly regarding interest rates and inflation.  Here, Smith’s analysis tallies neatly with the findings of our Investment 360 index, now in its seventh year.

Moving on down

Our survey of 150 corporates, investors and advisers across the UK revealed that 95% expect inflation to come down to the government’s 2% target within five years, while more than half believe the target will be reached by 2025.

Smith agrees on four counts. First, energy prices are probably past their worst. Second, there is no evidence of a sustained wage spiral. Third, quantitative easing is now over, so money supply is no longer rising. And fourth, producer price inflation is falling, in terms of both input and output.

Smith does however question whether maintaining inflation at 2% is sustainable, or even desirable. Until recently, he points out, advanced economies benefited from ‘the China effect’, which kept the price of goods low for decades. Now this effect is more muted and global trade is less open. That means goods price inflation is likely to be stronger, while service price inflation tends to run at between 3 and 4% across economic cycles.

“It’s time to ask whether 2% inflation is still an achievable long-term target,” Smith suggests.

Too much, too slow

On interest rates, Smith also concurs with respondents to the CIL survey. Reflecting on last month’s decision to keep interest rates at 5.25%, Smith believes this was the right decision and says further hikes could be hard to justify unless wages start to spiral higher, a scenario for which he sees no evidence.

Smith goes further, stating that the Bank of England has already increased base rates too much and suggesting that rates of 4% to 4.5% would have been quite enough to bring inflation under control. “The Bank got trapped into responding to bad inflation data, rather than looking forward, trusting in its own judgement, trusting in its own forecasts and looking at the wider picture for the economy,” he says.

CIL respondents are equally critical. Nearly 30% believe the Bank of England is doing a bad job, having reacted too slowly to inflation figures last year and then moved too far the other way. With this in mind, 93% of respondents now believe that rates should either stay the same or fall.

On one hand, this reflects optimism about inflation but also reflects concerns about economic growth, with half of respondents feeling negative about the UK economy over the next 12 to 18 months and only 19% feeling positive.

Growth, but not much

For Smith too, the short-term picture is somewhat mixed. Real incomes are now rising, as inflation falls, and many households, particularly older ones, have built up £2bn to £3bn of savings since the pandemic. As most of those savings were essentially built up during successive lockdowns and were therefore “involuntary,” that money could trickle into the economy over the next few months and beyond. Against this, the impact of all those rate rises has yet to feed through to the economy. Many home-owners are mortgage free and even those with mortgages are largely on fixed-rate deals so they are only beginning to feel the full force of the Bank of England’s actions. More widely, employers are only starting to respond to the tighter rate environment, particularly in terms of staff numbers. Smith expects that to continue, which should ease labour shortages but may also increase unemployment.

Smith does, however, believe that the UK will avoid falling into recession and forecasts growth of 0.5% this year, marginally higher than the IMF. Admitting that the UK still faces productivity challenges and needs to develop a more dynamic, faster-growing economy, Smith does believe that businesses and consumers have shown surprising resilience since the pandemic.

Hardy households

Looking back to the summer of 2021, he points out, there was a widespread belief that ultra-low interest rates were here to stay. By December of that year, the Bank had begun to raise rates, moving at an unprecedented pace thereafter. This could have had catastrophic consequences. So far, it has not. Confidence plummeted last year, as the cost-of-living crisis erupted, but consumers have begun to feel more positive in recent months – and businesses seem more optimistic too.

“It could have been a lot worse,” says Smith. He also predicts that the Bank of England may well start to bring interest rates down faster than they have led markets to believe, falling to 3-4%, barring any further shocks and surprises.

Confidence among our Investment 360 Index respondents improves over time as well, with 54% feeling positive about prospects in the next five to ten years and only 14% remaining downbeat about the long-term outlook.

A skip in your step

Even now, Smith’s proprietary economic indicator – the skip index – provides a degree of reassurance. No skips in Smith’s street suggests that we are in a recession. Four or more suggests an unsustainable boom. Two means the economy is enjoying ‘trend growth’ – neither too hot nor too cold. Having waxed and waned rather unpredictably through the pandemic, there are now two skips in the street – a sign that conditions are normalising.

In the Four Horsemen of the Apocalypse tale, trouble and strife are followed by utopia, a new beginning. That may be some years away but, as Smith acknowledges, it seems as if the worst is behind us.


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