A Bull Case for the UK
Falling interest rates and some sensible policy reforms
Much has been written about the precarious state of the UK economy that a new government will inherit. Growth is low, debt is high, and taxes are high. The country seems in a bit of a funk, lacking shiny tech superstars and battling creaking public services. I would note that I secured a doctor’s appointment for my son last week in a remarkably efficient manner; my (American) husband’s response would be my expectations are so low that what should be normal seems exceptional.
It is easy to lapse into a tale of decline, as this story has been told many times before. Since the US overtook Britain as the world’s foremost industrial power in the late 19th century, the UK has grappled with different narratives of falling behind, when the reality is that it was, and remains, among a small group of rich nations in which you’d be more than happy to be born. Still, making a bull case for the UK does not come naturally to most Brits, so let’s give it a try here.
The Bear Case
First, it’s only fair that we set out why things feel quite so gloomy:
Low growth, high debt, high taxes: UK growth has languished over the last decade, with the economy never quite picking up steam after the financial crisis. Real wages were still close to pre- financial crisis levels in mid-2023, meaning 15 years of lost wage growth. Since the pandemic (Q4 2019) the UK has been the second worst performing economy in the G7. At the same time, debt to GDP is at its highest since the 1960s, as is tax as a share of GDP.
Long-term productivity rut: The driver of this has been a dramatic slowdown in productivity growth, leaving GDP per hour worked 28% below the US, 13% below France and 14% below Germany. Productivity drives living standards as more productive workers can secure higher wages (which is obvious if you look at US vs UK salaries for equivalent jobs). Recent research has highlighted the UK’s failure to invest as the major cause of its productivity slowdown.
Ongoing drag from EU exit: Lack of investment is a story that pre-dates the country’s most recent European crises, but it’s also clear that the Brexit vote was a nail in the coffin for a weak investment culture. Most estimates now put the impact of EU exit on investment, productivity and trade as costing the UK 4-5% of GDP.
An ageing (and sick) population: One positive for UK growth forecasts in the OBR’s latest assessment is that we discovered we had 1 million more people than previously thought! The UK also has more favourable demographics than other large economies (population is still growing). Unfortunately, the short-term positives of having more people are offset by fewer people of working age being in work, with long-term illness rising dramatically since covid, likely reflecting pressures in the health service. Persistent long-term illness, combined with an ageing population, and a desire for less migration, could mean fewer workers, limiting the economy’s potential growth and adding to inflationary pressures.
The Bull Case
Now let’s cast aside that negativity, and turn to what could go right:
Interest rate relief in sight: The UK was hit hard by the energy price shock accompanying Russia’s invasion of Ukraine, which, off the back of the supply pressures built up during Covid, saw inflation peak at 11.1% October 2022. Energy prices aren’t going back to 2020 levels, but they are falling considerably, and while services inflation remains high (6 percent y/y in April), it’s hard to see this persisting if the current boom-bust cycle in the consulting industry is to go by. Private sector wage growth (5.8 percent y/y in May) is elevated but with clear signs of a cooling labour market (hello again, consulting industry). The data (and general sentiment) no longer support spiralling prices, and market expectations for the Bank of England to start cutting rates later this year seem reasonable, providing some respite for mortgage holders needing to refinance off short-term fixed rates.
Strong balance sheets, stable conditions, rising confidence: In many ways it’s remarkable how well the UK consumer and corporate sectors have held up in the face of rising prices and interest rates. The economy dipped briefly into recession in 2023 and growth has been far from US stimmy-fueled levels, but unemployment remains low with no widespread firm or household distress. This resilience is less surprising if you look at the strength of balance sheets – UK household savings rose significantly during the pandemic, as did levels of corporate cash. While these savings are unevenly distributed (concentrated among higher income households), a more stable economic and political backdrop could support a sweet spot where falling inflation meets rising real wages, greater confidence, and a growing propensity to spend and invest.
Squaring the fiscal circle: There is almost unanimous consensus that current UK fiscal policy doesn’t stack up, with borrowing constrained by higher interest rates, memories of Liz Truss, and pledges from both parties to avoid raising taxes meeting rising demand for better public services. The Labour party’s plans to tax private equity more and put VAT (a sales tax) on private school fees look small fry. But if you add upping rates on capital gains, ending tax breaks for the self-employed, making pensioners pay national insurance, reforming property taxes, and rethinking the mechanics of the Bank of England selling its gilt portfolio, it starts to look like real money. Not that Labour has announced any of this, but there’s money there if a government has the courage to find it.
Reforms for growth: Combine some sensible tax changes with some pragmatic reforms to the UK’s relationship with the EU, targeting a deal on animal and veterinary standards to support UK agriculture and food producers, and some acceptance of EU standards in other areas (e.g., attempting to rejoin the EU’s REACH regime in chemicals), and you start to have the foundations of a credible growth strategy. Add planning reform to make building infrastructure and houses easier, plus higher defence spending, and it’s reasonable to expect a notable expansion in public sector investment over the next five to ten years, funded through the tax reforms noted above plus some additional borrowing. Raising public and private investment becomes the key to unlocking future growth.
Yes, the bull case requires a leap of faith, but isn’t that always so? A lot hangs on policy reforms, and if you subscribe to the “politics doesn’t make a difference” view of the world, look elsewhere. But if you think policy can matter, it’s not unreasonable to make a case for a rosier outlook for UK growth than currently expected.
What does that mean for a UK investor?
“You can’t buy GDP” is an oft-used phrase, but if UK growth turns out higher than forecast, you would expect smaller, domestically focused UK companies (some, not all, of the FTSE 250) to outperform, driven by earnings growth and rising valuations (which have lagged both the FTSE 100 and US markets materially). If public investment does rise, there’s probably a lot more runway for UK construction, industrials and defence-related stocks; and even if it doesn’t, there’s still a lot of cheap UK companies and a lot of private equity money sloshing around!
All of this should be supported in the long term by a rebuilding of the equity investment culture in the UK. UK pensions funds invest barely any of their assets in domestic equities; and UK retail investors have long chosen property over stocks as the way to fund retirement. This isn’t going to change overnight – and there will be fits and starts and plenty of muddled reforms along the way - but the crucial point is that increasing UK investment in UK companies is high on the political agenda today, when it was barely discussed five years ago. There is a direction of travel that has been set, which could help rebuild the investor base for UK firms. I’ll return to this in a coming post.
And there you have it, a bull case for the UK.