Autumn economic outlook for businesses

In the latest in the series of pathfinder articles, Phil Eckersley examines the latest economic news and its implications for the business community. 

The last few months have seen a slew of economic data as well as plenty of media speculation about the Labour government’s policies.  Economic growth has continued its robust momentum, stimulated by strong household consumption in the second quarter, underpinned by successes in the Euros and Olympics.  Business services remained positive, inflation has slowed and some pressures in the labour market have eased. 

However, the existential threats from the international outlook continue to harm prospects, with concerns about global growth leading to a market correction in August and a flight to safe-haven assets.  Geo-political tensions persist, and asset managers remain nervous about values.   Finally, further fiscal tightening appears on the near-term agenda.  Higher taxes, unless astutely targeted, typically weigh down on growth. The new administration’s first Budget on October 30th looks like it’s going to be an interesting one!  

The international outlook

Concerns emerged in August about the sustainability of US growth following the toxic mix of the so-called Sahm rule (this predicts a recession when the unemployment rate rises by at least 0.5% from a low point within a year), Japanese carry trades and China.  China’s economy appears to be contracting, facing huge policy challenges around post-bubble debt deflation.  Second-hand house prices continue to lose value, quite rapidly in some regions, falling in most months since 2021. 

This fall in asset prices weighs heavily on indebted homeowners in China, reducing consumption and exaggerating precautionary savings behaviours.  At the same time the Eurozone is in manufacturing recession with Germany still suffering from elevated energy costs and a legacy of dependency on older technologies in sectors like automotive.  Euro-area tightening of Fiscal policy, counteracted by some easing of Monetary Policy, offers limited respite. 

But is this all bad?

Economist Joseph Schumpeter argued that market corrections can be healthy.  He is credited with coining the term creative destruction, a process of what might be thought of as industrial mutation, similar to the farming process of burning the stubble.  The theory being that correction revolutionises economic structure from within, destroying the old processes and replacing them with new ones. 

In the post financial crash period, it was argued, that the emergence of zombie companies in a low-interest rate environment led to resource mis-allocation.  However, with borrowing costs much higher at present this should lead, according to the theory, to much more efficient utilisation of the factors of production as the weaker firms fail replaced by more efficient ones.  

What about UK growth?

The UK economy has beaten most commentator expectations in the first half of the year growing by 1.3%, according to the latest data released by by the ONS.  This is faster than any G7 counterpart, exceeding the US which expanded at 1.1%, while the French and German economies grew at a more mundane 0.6% and a paltry 0.1% respectively. 

It is unlikely that this momentum will be sustained through the second half of the year, but it should remain positive.  It has caused global forecasters to employ the Tipp-Ex, revising UK growth expectations upwards.  Some of the stimulus (along with the feel-good factors mentioned above) must stem from the growth in real incomes as wages outpace inflation, from population growth and some from business investment, all of which remain positive. 

UK businesses – what should they be thinking about?

This mix of economic theory and data may have most business people running for the hills, wondering what the implications are for day-to-day business. Tomes have been written about the application of economic theory to business behaviours, so I won’t pretend to offer a panacea for those still reading on.  However, there may be some pointers.  

The interest rate cycle looks likely to continue to ease over the next year, probably settling in the 3.0%-4.0% range.  This has made fixed term lending more attractive as an offer, but with rates coming down, businesses may prefer to keep their powder dry in the near term, waiting for rates to fall further before signing finance deals. Furthermore, if the economy continues to expand the risk premium associated with borrowing costs should fall.  For those with a strong capital base, this could provide an agenda for a conversation with their finance providers. 

The likelihood of increasing labour market legislation, under the dual guise of Labour’s Fair Work Agency and potentially higher employer NI charges, may tip the balance in favour of capital investment rather than additional labour.  As businesses strive to generate new business the domestic economy appears more receptive, at least in the short-run, than the G7 economies.  And of course, there are plenty of strong-growth economies beyond the G7 worth exploring.