United Kingdom: RIP Adidas Sambas And Broader Economic Analysis

Some things are a great distraction from it all. Like trainers, I like trainers. I’m a Nike fan myself, but dabble elsewhere. Some pairs of Adidas are pretty perfect, like those Sambas. Universally accepted by everyone from uni freshers to football hooligans, Samba was shoe of the year 2023 according to Footwear News. They were “perennial bestsellers” providing a “halo effect” for Adidas’ global brand according to the firms’ 2023 financial statements. Ah what a trainer.

Alas, all good things must come to an end, and of course, PM Rishi Sunak is at the centre of it. Here it is in all its glory. For those of you who don’t like clicking strange links on the internet and have been living under a rock for the last week, we have Sunak donning a white shirt, trousers and a pair of white Sambas while being interviewed in number 10 about his cuts to national insurance (I’ll get to this later, budget blowout anyone?)… Fast forward a few days and Sunak has issued an apology to all Sambas fans. However, the damage is done. Irreparable damage.

Sambas Cool vs Uncool Index

UK – Google Search Intensity For Sambas (Peak weekly searches = 100) Vs JB Macro Cool Vs Uncool Index

*A value of 100 means Sambas are cool, a value of 0 indicates that the Prime Minister has worn them with suit pants. Source: Google Trends, JB Macro

With my only distraction polluted, I guess this means I have to talk about politics.  

So how have things changed since our last review back in January? Three months in an election year is a long time so what’s new? In the 120 voter opinion polls so far in 2024 (as of 14 Apr), Labour have averaged 44% of the popular vote, which is… oh, exactly the same as the average over Oct-Dec 2023. This Labour popularity is in spite of the first major ructions within the party, over Israel-Gaza, and this is withstanding a major policy U-turn on Green Investment. So Labour are still storming ahead, and the Tories are struggling to find a chink in the armour (this Angela Rayner tax stuff seems a bit desperate in my opinion).

This Chart Makes Rishi Sunak Sad

UK – Parliamentary Election Polling, % of voters, 20 poll MA

Source: Various National Pollsters, JB Macro

Well at least that means the Tories have stopped haemorrhaging popularity, right? WRONG. After the Conservatives surrendered the centre ground to Labour, they have gone about handing over big chunks of vote on the right to Reform UK. Reform has polled at an average 11% of the popular vote in 2024 to date, up from 7% over Oct-Dec, boosted as Sunak decided that the shift to the right in 2023 went too far, but without him really shifting the party back to the centre. So, the Tories are marketing themselves as socially on the right, but not like as far to the right as Braverman was, but also definitely not David Cameron/Theresa May centre-right Conservatism. So, they are kind of centre of the right but not centre-right, right?

On a serious note, Tory strategy seems a little wild. Think about it, they smashed the 2019 election with BoJo at the helm, promising the Red Wall Labour heartland that they would spend big while leaning to the right on social issues (fiscally liberal, socially conservative). At the same time, they alienated the London commuter belt vote (which is typically fiscally conservative and more socially liberal) but they still did well there in 2019 given Corbyn was the other option, and the Lib Dems were still trying to climb out of their pit of despair. So these areas stuck with the Tories while the party won seats further away than any Londoner would dare to go (the North East).

Smaller Government At Odds With Retaining Red Wall Seats

UK – Parliamentary Seats That Flipped Conservative In 2019, By Region.

Note: There are 650 seats in parliament. Source: House of Commons Library, JB Macro

Anyway, Sunak has indicated he is pivoting the party back to its fiscal roots (lower tax lower spend) while remaining fairly right wing on social issues. But who is this even trying to appeal to? The London commuter belt is put off by the social conservatism and the typically poorer Red Wall doesn’t like the pull back on public spending (not to mention failures to deliver on policy such as Levelling up, healthcare, and housing). It seems like a stupid prediction to make given it’s the obvious one and I’m sure I’ll regret it, but this election is really looking like it could be a ‘97 style whitewash. Especially if the vote on the right continues to fracture between the Tories and Reform. (For a disclaimer, I obviously don’t think I will be, but I might be wrong due to new voters ID rules which would disproportionately result in younger, typically non-Tory voters being turned away, the massive redrawing of constituency boundaries for this election, and any number of possible random events/scandals – forecasting politics is hard).

So now the fun bit! What does this mean for policy?

Well, if I were a UK corporate, I would be much more focussed over the next two years on the macro backdrop given the actual policymaking outlook is DREARY (we will explore the economics below). Think about it, according to the most recent quarterly date, the budget deficit came in at 5.8% of GDP in Q3 2023. Debt is hovering around 100% of GDP which according to this very cool dataset from the OBR is the highest debt to GDP ratio the UK has had since 1961. Besides this, Chancellor Jeremy Hunt has instituted 4 pence on the pound worth of cuts to National Insurance rates which haven’t worked into the figures yet (headline rate from 12% to 8% of income). The tax burden is already massive at the moment (over 40% of GDP, the highest level since the ‘80s), debt is punching higher and the OBR’s report on Hunt’s spring budget revealed it had an absolutely tiny amount of fiscal headroom (GBP9bn) to remain within the Government’s fiscal rule (debt to fall on a five-year horizon).

Show Me The Money! Please…

UK Fiscal Figures, GBPbn, ex public sector banks

Source: ONS, JB Macro

It doesn’t matter who is in government after the coming election, the options are exceptionally limited. Sticking to the idea that Labour will win the election, what might we expect? Well, the party has committed to keeping the 25% corporation tax rate steady for the next parliament and full expensing of business capital allowances is to remain too. Broadly, expect a close to business policy platform (absent increased employee protections such as a proposed ban on zero hours contracts).

That said, the party has some fairly ambitious spending plans, especially on healthcare and green investment (although the latter isn’t quite so dazzling anymore). So how are these going to be financed? *Cough* income tax rise *cough*. Which as painful as it sounds, likely makes sense. The demands on the state over the next decade are going to be intense and will need money, for example aging populations, green investment, and increased military expenditures without even considering other challenges such as levelling up/improving creaking national infrastructure. So in a first year of parliament, maybe expect an income tax hike, some more money for the NHS, and potentially some reforms which would be well signposted in a Labour manifesto (keep an eye out for policy aimed at the House of Lords). Other than that, it’s probably going to be a bit boring/anticlimactic (this could be such a bad call).

Ok that was tough. So now the easy bit, how are we looking on the Macro?

I like keeping this as honest as possible and owning the mistakes, so then we can learn from them. As a caveat, the whole point of this exercise is for you to glean some relevant information that might guide your thinking on some decision at some point, or maybe it is just a light bit of entertainment (wow I know how to have fun!). With that caveat, let’s assess how we did last quarter.

Lawrence J Peter: “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today”… Boy was I wrong last time. Let me dig up a quote from my January piece, “you know what, Q4 looked pretty OK!” Jeeze, Q4 2023 GDP came in at -0.3% q-o-q in the end (released 15 Feb), confirming that the UK spent H2 2024 in recession. What a bad call!

So where did we go wrong? We premised the outlook on pretty buoyant survey data such as PMIs and GfK’s consumer confidence indicator, which suggested a positive shift in activity possibly on the back of falling inflation and still decent wage gains. What the hard data has shown us after the fact though is that we were way too early on our call: real activity measures such as retail sales, industrial production, and the ONS’ monthly GDP series all suggest that the economy has rebounded slightly in Q1 2024. The lesson I have learnt from this is that right now, soft data is not very useful for forecasting – this is something that is observable in parts of Europe too for instance – and might make sense given the effect of inflation on people’s perceptions of activity. People might judge their life nominally (yay my pay is up) and respond accordingly in survey data but that might not directly translate to their activity (inflation, fear factor, etc) which could lower the usefulness of survey data.

Modest Rebound From Recession Underway

UK – Monthly GDP

Source: ONS, JB Macro

Given this uncertainty, it seems appropriate to take a step backward and take stock of the fundamentals and piece together a more concrete outlook for the medium term. We know that:

1. The demand side of the economy looks pretty shot. Pandemic related savings have been drawn down, credit is more expensive after the hiking cycle, and the fiscal backdrop looks fairly certain to tighten up.
2. The supply side looks ok for now, but there are risks everywhere. Rising tensions between Israel and Iran could cause oil prices to shoot up, compounding a big reflation trade in commodities that has been in play since February. Global risk off would be GBPUSD negative, and potentially inflationary.
3. Inflation is falling, but pay growth is also falling as labour market slack is increasing. Insolvencies remain near 2008/09 peak levels.
4. The BoE’s assessment is that point 1 might not be quite bad enough yet, the Bank is fearful of risks per point 2, and wants to see more progress on point 3. It’s a little dated now, but BoE Chief Economist Huw Pill’s March 1 speech (page 11) sets out this assessment really clearly. The BoE could cut Bank Rate from its present 5.25% at the next policy meeting on May 9, but is more likely to wait until June 20, and even then could baulk at pulling the trigger until August 1 given the Fed looks much less likely to cut after the release of March CPI data (which confirmed a modest resurgence in inflation).
5. Real interest rates continue to rise and a bond maturity wall is on the horizon in 2025 and 2026. Both of these bode poorly for the fixed investment outlook but are unlikely to be catastrophic.

I don’t know about you, but 1-5 don’t look so positive to me.

GBPUSD 1 Year Chart

Source: Bloomberg, 16th April 2024

At the time of writing (16 Apr), GBPUSD is trading around 1.2450, having broken sharply down through 1.2500 on the aforementioned US CPI print on 10 Apr. This is a far cry from highs reached last week of around 1.2700 reached last week. Looking ahead, to me it appears that the downside is far from in. Traders have not priced the risk of a May cut at the BoE at all and a June cut is only 40% priced. This comes as the demand outlook in the US is much stronger and the risk over there is that the Fed puts rate hikes back on the table (recent speeches from key Fed Governors have made it clear that they are in wait and see mode for the next couple of months so surprise dovishness is very unlikely). Meanwhile, escalations in the Middle East favour a lower GBPUSD while cable has not adjusted down yet in line with a lower UK-US yield differential nor in line with a lower EURUSD (which it tends to follow). Furthermore, GBPUSD is now below technical resistance at 1.2500. This analysis holds for the next month or two, after which the rates narrative may have completely shifted again and elections in the US may have started dominating the narrative.

So how do we translate these prospective market moves into something a bit more actionable?

For importers, avoiding against complacency is key. Simply because GBPUSD has spent most of the last 12 months in the higher reaches of the 1.20’s doesn’t mean the next 12 months will be mirrored and the horizon is cluttered with risks.

For exporters, timing is everything. Yes, there does appear to be more scope for GBPUSD to grind lower amid the fragile global risk background, besides political uncertainty and macro headwinds. How low it goes and over what period are the tricky questions. It’s important to remember that the US heads to the polls in November – at some point this year electoral risk will surely become the dominant driver of GBPUSD price action and may push several pronounced bursts to the upside.

Ultimately, GBPUSD trading sub 1.2500 over the medium term may open up opportunities for exporters. Sterling has been increasingly overvalued in real terms since February 2023, reducing external competitiveness, with the latest REER data point (Feb 24) showing the unit was 6.0% overvalued (as compared to its five-year moving average). Since then, sterling has sold off in nominal terms, and UK inflation has continued to fall while US inflation has accelerated. Should this trend continue, UK exports may become much more attractive.

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Contributors

James Bennett

Guest Economist

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Views expressed in this article are by James Bennett, JB Macro, guest Macroeconomist.