The UK Macro Environment

Episode Summary

Executive Summary: Goldman Sachs economist Kevin Daly argues the UK’s recent outperformance stems from Bank of England credit easing, easier credit conditions, and lower oil prices, which should support 3% growth in 2015-16. He expects inflation to stay near zero this year, wages to begin rising, and the first BoE rate hike toward year-end, while noting risks from weak euro-area conditions and housing supply shortages.

Main Topics: Drivers of UK economic outperformance (Priority: 5/5): Daly says the UK moved from post-crisis underperformance to strong growth because the BoE shifted from QE to credit easing in 2012, improving credit provision to households and businesses, while ECB risk-reduction boosted confidence. Impact of lower oil prices (Priority: 5/5): Lower oil prices are presented as a major stimulus to UK growth, with benefits arriving more slowly than the immediate hit to inflation. Daly expects the full growth effect to take several quarters to materialize. Growth outlook for 2015-16 (Priority: 4/5): Goldman is more optimistic than consensus, forecasting 3% growth in both 2015 and 2016 versus around 2.5% consensus, supported by improving credit conditions and cheaper energy. Labor market, wage growth, and participation (Priority: 5/5): The UK has record employment and low unemployment, but wages have been weak because labor supply rose, especially among older workers due to pension and retirement rule changes. Daly expects wages to accelerate this year. Interest rates and inflation (Priority: 4/5): With inflation very low and close to zero this year, the BoE has kept rates low. Daly expects the next rate move to be up, likely toward year-end, but sees risk of a delay if inflation stays weaker than expected. Housing market constraints (Priority: 4/5): UK house prices remain elevated because of chronic undersupply and planning constraints. Daly argues the UK is unlike the US housing bubble story; prices are high largely because supply is structurally limited. Policy and political backdrop (Priority: 3/5): The March budget is described as having minimal economic impact because it was shaped by the election cycle. Euro-area conditions remain a key external risk, though recent political and currency developments have improved the outlook.

Key Arguments: The Bank of England’s shift from QE to credit easing in 2012 was the key policy change that improved funding costs and credit availability, supporting growth. The combination of easier credit and reduced euro-area tail risk after Draghi’s 'whatever it takes' statement helped confidence and lending. Lower oil prices act as a net positive for the UK because the country is a consumer rather than a major producer of oil. The growth effect of cheaper oil lags inflation effects by three to four quarters, so more support to GDP is still coming. UK wage growth has been unusually weak despite strong employment because labor supply increased, especially among older workers. As labor market slack disappears, wages should start to rise and eventually lift inflation pressures. The Bank of England is likely to raise rates only after inflation bottoms out; the first hike is expected late in the year, not immediately. The UK housing market is expensive primarily because of chronic undersupply, not speculative excess on the scale seen in the US before the crisis. The March budget should have little direct effect on growth because it was designed mainly around election politics rather than economic reform.

Data Points: UK GDP growth forecast: 3% in 2015 and 3% in 2016 - Goldman Sachs forecast shared by Kevin Daly Consensus GDP growth forecast: Around 2.5% - Market consensus for both 2015 and 2016 Oil price impact on GDP level: ~1.5% boost to GDP level - Estimated total effect of lower oil prices on the UK economy Oil price impact on annual GDP growth: Close to 0.75% per year over two years - Derived from the 1.5% GDP-level estimate Inflation outlook: Close to zero through this year - Expected UK inflation due mainly to lower petrol prices Unemployment rate: Below 6% - Current UK unemployment level mentioned in the discussion Employment rate: Record high - UK employment performance relative to history and peers UK house prices: Up 8% last year - Recent housing market performance Housing supply: Chronically undersupplied - Structural explanation for high UK house prices rather than a bubble Podcast recording date: March 30, 2015 - Timing of the episode and economic commentary

Pivotal Quotes: "the Bank of England in the middle of 2012, they swapped their focus from quantitative easing to credit easing" — Kevin Daly: Explaining the main reason for the UK’s economic turnaround "the next move in interest rates in the UK is going to be higher rather than lower" — Kevin Daly: His view on the direction of BoE policy as growth strengthens "The UK is almost more like the Manhattan housing market rather than the US housing market." — Kevin Daly: Describing why UK housing prices are high due to supply constraints

Implications: The UK’s near-term outlook is constructive: cheaper oil, better credit, and tightening labor markets should support growth and eventually wages. The main risks are delayed inflation, a slower rate-hike cycle, euro-area weakness, and persistent housing shortages.