A Sprinkle of Festive Cheer

The financial media’s response to recent economic data has been something of a frustration for me recently and so I felt compelled to write about it. In all the gloom I hear about the UK economy, I just wanted to sign off the year with a more upbeat, fact-based narrative. Those who follow this blog may well be familiar with this refrain but may also be aware that I have been too optimistic in the short term. In summary, I have underestimated the impact of the Labour Government’s, and especially the Chancellor’s, relentlessly downbeat message on the state of the economy, which clearly had a negative impact on consumer and business confidence. The budget in late October compounded this effect by significantly increasing taxes on business.  

Unfortunately, undimmed by the widespread criticism of her budget, including this week from the Governor of the Bank of England, Rachael Reeves was at it again in an interview in the Guardian. In it, she again talks about the terrible economic inheritance the government has taken on and the impossibly difficult choices the government is confronting. By implication, this refers in part to government borrowing, but she ignores the fact that the deficit in 2024 is the same as in 2023 despite the last administration’s £20bn cut in employees’ NI, which came into effect this year. In other words, in a disappointing year for growth, the economy is still generating increasing tax revenue and the deficit, as a % of GDP, fell to close to 4% (see below). By way of comparison, in the US, the deficit is over 6% of GDP, as it is in France, and it’s over 7% in Italy.

If it is your intention to grow the public sector and to increase the scale of government spending in the economy, which, of course, is the Chancellor’s objective, then it helps to portray the problem (higher taxes, more borrowing) as the product of an awful inheritance, rather than the product of a politically driven ambition. I find this whole debate more than a little irritating, not least because it is based on a fundamentally dishonest position. In opposition, the Labour Party advocated for even longer lockdowns during the pandemic and more government help in the cost-of-living crisis, both of which led to the incredible spike in the deficit shown in the chart above. It should be surprising to no one that the product of these unprecedented government interventions is a legacy of higher borrowing.

In the Guardian interview, Rachael Reeves goes on to talk about her ambition to “boost growth” with planning, pension and regulatory reform, all of which, in principle, I agree with. I fear the measures we are likely to see will be too timid and take too long to implement and, like so many government promises, will achieve very little. For what it’s worth, my advice to the Chancellor would be to have a radical ambition to shrink the public sector, to properly address its terrible productivity record and to get out of the way of the private sector, which is the only thing that can generate wealth here in the UK. I won’t hold my breath. Nevertheless, I remain optimistic that the UK economy will perform well over the next two years despite all the negatives we hear so much about.

Let’s start with retail sales, which were disappointing in November. This year, this data didn’t include the traditional Black Friday extravaganza, which fell on November 29th. The traditional spike in sales seen over this period will be included in the December data, which should be very strong as a result. I also expect GDP data for the last few months of the year to be better than in September and October. However, more important is the outlook for next year.

My view is that the economy will be driven by stronger consumer spending and better investment spending than the consensus expects. Of course, we will also see about 0.75% higher GDP simply from higher government spending. So, adding this lot up, I think 2% growth is more than achievable. If consumers decide to save less (saving is currently 10% of disposable income – see below) in the future, which seems to me a reasonable assumption given the dramatic increase in saving since the pandemic, then growth could be even stronger. Remember, UK households in 2025 will also benefit from another year of strong real wage growth.

I also expect consumer and business confidence to benefit from lower interest rates, which will start to come down in February with three further cuts in May, August and November. In my view, the MPC has been way too cautious about rates. By way of comparison, in Europe, which shares the same inflation rate (2.5%) as the UK, rates are down at 3%, and in the US, where inflation is again roughly the same, rates are now down at 4.25-4.5% despite the boost to come from lower taxes. Here in the UK, rates are at 4.75%, growth has stagnated in Q3/4, and taxes are rising. This doesn’t make sense to me.

One more bit of good news is the housing market, which had a much better 2024 than many had forecast. Mortgage approvals have risen by a third in 2024, housing transactions are up 20%, and house prices are up 5%. The market carries good momentum into 2025, and I expect it to continue to do well as rates come down. Given rates have increased, you might ask, “How can this be?” The answer lies in the fact that wages have risen strongly, so affordability remains good. Indeed, banks have sold the same number of mortgages in 2024 as they did when rates were half what they are now (see below).

The government could do much to help this vitally important but still cyclically depressed market. Unfortunately, it seems wedded to the legacy of ludicrously high stamp duty land tax rates, which completely stifle the second-hand market and create structural rigidities in the economy that constrain growth. (Rachael, here’s an idea for you!)

So, in conclusion, despite being too optimistic recently, my confidence in the UK economy’s ability to smash consensus expectations in 2025 and 2026 remains undimmed. The media narrative will remain depressing, and the government’s messaging will be unhelpful, but the reality is that the outcome will be much better than we all might think. Before signing off for 2024, I should also add that this backdrop will be a very positive surprise for UK equities, especially domestically focused ones, which I expect to have a good year in 2025, too. If you haven't already, you can download a copy of my full outlook for 2025 here.

Happy Christmas to you all, and best wishes for 2025. Thanks very much as well for your support and feedback. Please keep it coming!