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Our views 10 October 2022

JP’s Journal: The start of the growth debate… or the end?

5 min read

“Growth, growth, growth” was the Prime Minister’s mantra at the Conservative Party conference last week. The challenge for a leader whose party that has been in government for 12 years is: why has growth been so poor under its stewardship?

There are lots of answers, but the facts remain that UK productivity has been on a downward trend since the Great Financial Crisis (GFC) and productivity is a key driver of growth.

There were two contrasting articles last week that looked at the Prime Minister’s speech. The first was by Janan Ganesh of the Financial Times, one of the most articulate and insightful journalists writing on politics. His argument is that we need to have a national conversation on how to improve growth, but because the Prime Minister and Chancellor have mishandled the situation, that debate will now not be had.

Conversely, Matthew Leash, Head of Public Affairs at the Institute of Economic Affairs thinks the question of how to achieve higher growth will now be at the centre of political debate.

I find myself more in the Ganesh camp as the Government’s approach is being characterised as unfair and uncaring, which will hinder attempts to deliver on the supply side changes.

Can the UK economy grow at 2.5% as the Chancellor is targeting? I struggle to see it – even if the supply changes could be enacted. I don’t see a productivity miracle arising from them. On a shorter-term horizon, the dislocation of bond markets has worsened the growth outlook. A month ago, yield curves reflected a bank rate of 4.25%; today they price in 5.75%. Sure, most global interest rate expectations have moved up over the month – the US by 0.75% and the eurozone by almost 1% – but there is a clear mini-budget impact here. So mortgage rates are going up and house prices will probably be coming down. But, in addition, businesses are facing higher debt costs, and the combination will, in my view, push the UK into recession. Not what the Prime Minister and Chancellor intended.

The Bank of England’s (BoE) decision to hike interest rates by 50bps at the last meeting now looks timid. What is surprising is that, according to media reports, the Monetary Policy Committee considered the energy price cap in their deliberations, but not the mooted tax cuts. This is surprising given that the Prime Minister had been clear on her tax reduction policies. The November decision is likely to reverse this timidity.

Sterling credit looks attractive

Credit markets have felt the backlash from the turbulence in government bonds. The last two weeks have seen significant selling of credit by UK pension funds as they search for cash to provide collateral. This has been pretty indiscriminate and has pushed the sterling non-gilt credit spread towards 2%. This represents outstanding value from my perspective. Two things can undermine this view. First, inflation stays high, eroding the real value of future bond cashflows. Second, defaults rise as the economy adjusts recession. I remain relatively upbeat on those two outcomes. I think inflation will come down and that higher defaults are already priced in.

On the data front, US non-farm payrolls came in a bit above expectations. The unemployment rate fell back to 3.5% (where it had been in July before a jump in August to 3.7%) and the underemployment rate fell too. Pay growth was in line with expectations at 5.0%, down from 5.2%, but that’s still a strong pace of growth by pre-pandemic standards. Overall, the US labour market still looks tight and last week’s data suggests that talk of a Fed pivot is premature.

Government bond markets continued to be weak. US 10-year rates were marginally higher at 3.9%, while German 10-year yields ended at 2.2%. The UK continued to be a laggard, despite the BoE support: 10-year rates moved towards 4.25%, but the main change was in real yields as selling by pension funds pushed yields higher. For the first time in a long time, I think real yields in the UK are attractive.

So, let’s finish on growth. There is a debate on whether a push for growth is desirable – putting extra pressure on scarce resources. Yes, growth in real GDP is a crude measure of prosperity. But without growth how are we going to maintain the services and welfare support we expect?


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