With the United Kingdom emerging from a brief recession, Prime Minister Rishi Sunak has received much-needed support ahead of the anticipated general election which is all set to take place in the next few months.
According to figures released by the Office for National Statistics (ONS), the GDP increased by 0.6% in the first three months of 2024. The rise comes after the decline of 0.1% and 0.3% in the third and fourth quarters of the previous year. Two-quarters of an economic downturn in a row is the standard definition of a recession.
“Widespread growth” in the leading service sector, whose output increased by 0.7% in the quarter after declining toward the 2023 end, was the primary driver of the expansion in early 2024.
The Bank of England now anticipates that the United Kingdom’s GDP will increase by 0.5% this year, double the rate it predicted in February. In contrast, the GDP only increased by 0.1% in 2023. S&P Global’s survey of purchasing managers indicates that in April 2024, the combined output of manufacturing and services saw its biggest increase in nearly a year. Service companies were once again the growth’s main driver.
But the British economy is doing worse than those of its counterparts. The International Monetary Fund revised its prediction of 0.6% to 0.5% economic growth for Britain this year. Germany is the only developed economy with a slower anticipated growth rate than this one, out of the Group of Seven (G7).
Roger Barker, head of strategy at the Institute of Directors, a corporate lobby organisation, said, “Any recovery is still at an early stage and it is likely to be weak, but there are welcome hints of green shoots.”
Election approaching
Nevertheless, Rishi Sunak and his ruling Conservative Party will feel some respite from their severe defeats in last week’s municipal elections, which boded poorly for the party’s prospects in the general election. He faced additional humiliation as one of his legislators joined the opposition Labour Party.
The growth statistics, according to a statement from UK Finance Minister Jeremy Hunt, are “evidence that the economy is returning to full health for the first time since the pandemic.”
However, his Labour Party opponent, Rachel Reeves, stated that British households were still having difficulty despite the GDP growth. In the general election, polls indicate that the Labour Party will easily defeat the Conservatives. According to a YouGov study, 48% of participants said they planned to vote for Labour in the election, compared to 18% for the Conservatives.
Demons called inflation and unemployment
A return to economic expansion could potentially cause mortgage rates to remain high for longer, delaying the widely anticipated interest rate reductions.
Nomura analysts stated that “higher GDP growth enhances the risk of stronger demand pressures on inflation” and the GDP data “casts doubt” on an immediate rate cut. The European country’s annual inflation rate was 3.2% in April 2024, which is a significant decrease from almost 10% approximately a year earlier.
Governor Andrew Bailey stated that the central bank aims for a rate of 2% and anticipates approaching it in the next few months.
“We need more proof that inflation will stay low before we can decrease interest rates,” he said, while keeping the official borrowing costs at 5.25%.
Bailey further said that while a June interest rate cut was not out of the question, it was also not guaranteed and would depend on data on inflation and the job market.
Between January and March 2024, the unemployment rate rose to 4.3%, and the long-term decrease in job opportunities persisted, with 898,000 positions available during the reporting period, down 26,000 from the previous three-month period and, more significantly, down 188,000 from a year earlier. Although the number is still 102,000 higher than it was before the COVID-19 pandemic, that brief period when there was more employment available than unemployed people has long since passed. The most recent total of claims, however, was close to 1.6 million.
Generally speaking, employers want to wait to fire employees until necessary because redundancy programmes are costly, disruptive, and demoralising to the remaining workforce. If you make a mistake, having to locate new acquaintances is equally expensive and inconvenient. This is a case of some postponed effects from the recession that occurred in 2023.
Is the worst yet to come?
The next financial catastrophe is already visible to the Bank of England. It cannot put an end to it on its own. Bank executives worry that uncertainty in a crucial industry that has become more significant and risky in recent years could lead to another financial market collapse, a la, Liz Truss.
Concerns centre on the “nonbank financial intermediation” sector, a broad phrase that encompasses all significant non-bank investors, including hedge funds, pension funds, insurers, and private equity.
Global standard-setters have been struggling to govern this little-understood sector, but many officials feel that Britain needs to act more urgently given that four risky “nonbank” occurrences in as many years have nearly brought down the British economy.
There have previously been warnings from watchdogs in the European Union, the United States, and other countries about the market chaos that could result from a significant collapse in this industry. But because half of the finance for British businesses now comes from nonbanks and financial markets, Threadneedle Street faces an especially urgent issue.
As a result, any crisis or unrest might not only cause issues for the City of London but also directly impact the employment of thousands of individuals.
The Bank of England is unwilling to wait for the next mishap to occur. But since it can’t solve the problem on its own, it is advocating globally for a solution.
Speaking freely under anonymity, an EU source stated, “The UK has been clearly pushing it because of the size of the NBFI [nonbank financial intermediation].”
Before the next round of volatility causes significant economic harm, the Bank hopes that its battle scars will generate impetus for a global crackdown. It has set out on its path to resolve the problems, but in the absence of global unity, it might just amount to a never-ending game of whacking away at the next new issue that arises.
All eyes on BoE
The British central bank has been struggling lately. Reportedly, it had to reduce issues at UK pension funds back to manageable levels after the mini-budget of former Prime Minister Truss unsettled government bond markets.
Threats to the stability of the British financial system included the rush for cash at the beginning of the COVID-19 pandemic, the collapse of the Archegos hedge fund, and the turbulence in the nickel markets following Russia’s annexation of Ukraine.
These days, nonbanks make up half of the financial system, both in the UK and worldwide. In the United Kingdom, financial markets and nonbanks provide half of the capital for enterprises; in the European Union, this percentage is only 27%.
The concern is that this non-banking portion of the financial system has taken on all of the risks since the global financial crisis of 2008. In contrast, banks have been subject to mass regulations over the past 15 years, forcing them to strengthen their resilience after the global financial crisis rocked the underpinnings of the system.
Nonbanks gorged on cheap debt to boost investor returns during the post-crisis decade of low interest rates when copious amounts of money poured around the system. Central bankers worry they are more exposed now that the economic landscape is shifting due to higher rates and tighter money.
The BoE’s lack of knowledge regarding who has overindulged in debt and where is a serious source of concern. Sarah Breeden, deputy governor of the Bank of England, stated at a central bank seminar in February 2024 that “gaps in our knowledge have meant we are mostly creating resilience in market-based finance in response to crises, while we should be aiming to build resilience ahead of vulnerabilities crystallising.”
It is working alone to learn more. Senior BoE officials have issued warnings about the dangers hidden in private equity and private credit, which occur when investors lend money or purchase companies outside of public markets.
It will release more information on the possible threat that private equity poses to stability in June 2024, including an analysis of how prominent the investment giants’ companies are in specific areas of the British economy and whether or not they pose a greater risk than other types of businesses.
The executive director of the Bank of England, Nathanael Benjamin, issued a warning in April 2024 over “the development in sorts and amount of leverage, or ‘leverage on leverage’, throughout the ecosystem.”
Additionally, the bank is conducting the first-ever stress test of its sort to find out how nonbanks would respond to extremely high levels of possible market stress. In 2024, the results may lead to stricter regulations.
However, the UK central bank might be doing nothing since nonbank dangers are intrinsically worldwide. In reality, quick action is required from organisations like the Financial Stability Board (FSB), a worldwide watchdog, or its equivalents.
The core of the global reform agenda is becoming more and more focused on the topic of debt and where it might blow up markets. It might entail a crackdown on how some financial firms leverage borrowing to inflate returns to avert another global financial catastrophe.
Conor MacManus, director of financial services risk and regulation at PwC, stated, “You’d anticipate these to be areas of regulatory scrutiny, given over leverage and illiquidity are often at the heart of most collapses.”
The Financial Stability Board (FSB) will conduct a leverage consultation with a panel co-chaired by UK markets regulator Sarah Pritchard. The goal of the consultation is to address the underlying cause of the problem, rather than addressing it only when a catastrophe occurs.
However, that won’t happen until December 2024 and isn’t going to become official policy for a while, so it lacks the urgency the Bank needs.
There are some supporters of the BoE’s call for action. The European Union will propose certain measures for a broader framework in May 2024. Separately, meanwhile, there is growing disagreement over how far market regulators and central bankers should go.
This division has in the past limited the scope of changes; it was evident once more in the UK when chief markets regulator Nikhil Rathi played down the BoE’s worries about private equity.
The last thing the central bank wants is competition on its soil since development overseas is happening at a glacial pace.