Blowing hot and cold

Yet for many people, the fact that the UK is one of the fastest-growing economies in the advanced world does not match their own experience: wages have been falling in real terms and the country’s fiscal position is getting worse, not better.

For many people, the fact that the UK is one of the fastest-growing economies in the advanced world does not match their own experience

Last week, the Office of National Statistics released its second estimate for economic growth for the period from June to September. The headline figure was unchanged from the initial estimate of 0.7 per cent growth quarter-on-quarter, but the detail released on the drivers of that growth left the picture a little mixed. Expenditure from households and the government was stronger than anticipated, while business investment was on the soft side and net exports (exports less imports) created a sizeable drag to third-quarter growth.

Household spending has kept the UK economy going at a steady clip, but it is questionable whether the strength of the consumer can be maintained, particularly if the long-awaited pick-up in wage growth does not materialise. The upside of the decline in wages is that it kept the cost of labour low and meant businesses kept their existing staff and even increased hiring when the outlook was still less than rosy. The downside is that it has also made us less productive as a nation. Meanwhile, many of the jobs being retained were at the lower end of the pay scale, which ultimately has led to lower tax revenues for the Treasury and a budget deficit that is moving in the wrong direction.

The Bank of England still expects wages to increase in the coming year, as shown in the latest Inflation Report, just not at the pace it forecast earlier in the year. Wage growth remains the key to unlocking higher interest rates, as this will be the overriding factor for pushing up inflation over the medium term. Governor Mark Carney’s Mansion House speech earlier in the year had markets pricing in rate hikes by the start of the November just gone. But the lack of wage growth, and hence muted inflation, had given the BoE more wiggle room to leave rates lower for longer.

The minutes from the BoE’s monetary policy committee’s November meeting showed the same 7-2 split as previous meetings, with two MPC members voting to raise interest rates. However, decision-makers will be rolling with the data rather than the punches as far as the first rate hike is concerned. The balance of the committee has swung to the more dovish side of late, but it could easily swing back the other way if the increase in September’s wage growth continues and concerns about global growth start to fade, particularly with respect to the eurozone.

For the coming year, the general election casts the longest shadow over what could be another good year of economic growth as it brings plenty of investment uncertainty. The political backdrop poses a range of risks for the UK, particularly for the path of sterling. The possibility for a hung parliament should not be ruled out, while the spectre of a possible 2017 referendum on leaving the EU will also weigh heavily on economic prospects. The BoE could adjust its outlook and leave rates on hold longer than the mid-2015 consensus for the first rate hike. However, if the eurozone pulls itself out of the quagmire next year, the labour market continues to tighten and economic slack erodes, this should lead to increasing inflation pressures and the first rate hike by the BoE in more than five years.

Despite politicians’ best efforts, the UK economy could be set for another year of above-trend growth in 2015. Survey indicators point to continued robust job growth and further declines in the unemployment rate, which translates into higher wages. Business investment intentions are still robust and could complement a stronger household (if that wage growth is delivered) and support the economy next year – notwithstanding a possible fiscal squeeze. However, an unsettling political backdrop may mean investors will prefer to put their money to work elsewhere.

Kerry Craig is global market strategist of JP Morgan Asset Management