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Why there could be a little too much optimism around right now
Canadian American economist John Kenneth Galbraith once observed that ‘the only function of economic forecasting was to make astrology look respectable’.
His words came to mind when great credence was given to the EY ITEM Club lifting growth forecasts for the UK recently. There is hardly an abundance of exuberance on display, yet the new Winter Forecast sees the growth outlook upgraded from the 0.7% predicted in October to a still sluggish 0.9%.
There is more striking optimism on inflation, which is expected to fall to the Bank of England’s target of 2% by May and average 2.4% through 2024 compared with the previous forecast of 2.9%.
Off the back of this, 125 basis points (1.25%) of rate cuts are expected from the Bank of England, and this is expected to feed into an improved outlook for house prices and consumer spending, two especially important contributors to UK growth.
An improved outlook for the property market has been heavily priced into FTSE 350 housebuilder shares which are up nearly 35% on average over the last three months. Morgan Stanley thinks the market may have got carried away, observing: ‘Even if mortgage rates materially corrected, volume recovery is capped by planning bottlenecks and labour availability.’
If a surfeit of optimism is apparent at a sector and industry level, it might be emerging at a broader level too. Quoting Galbraith’s wry observation is not intended to ridicule the role of any forecaster, not least EY ITEM Club. There is value in looking at what they have to say and, in particular, why they are saying it. But, more than ever, the backdrop is fraught with uncertainty.
Geopolitical tensions are already feeding into renewed inflationary pressures as shipping costs surge off the back of disruption to routes through the Red Sea thanks to attacks by Houthi rebels. Middle East tensions are also sustaining higher energy prices which, as this column observed a couple of weeks back, might otherwise have fallen more sharply given the supply and demand picture.
The impact of the sharp increase in rate hikes since late 2021 has still not been fully absorbed by businesses and individuals alike. Many homeowners are still to roll off their fixed-rate mortgages on to higher rates and, as the latest Red Flag Alert from insolvency consultant Begbies Traynor (BEG:AIM) shows, 47,000 UK businesses are teetering on the brink.
According to the report, the levels of ‘critical’ financial distress increased by around a quarter for a second three-month period in a row, while a much larger number of firms – more than half a million – are in ‘significant’ financial distress.
These companies really need rate cuts, and soon. It remains an open question whether the Bank of England will deliver.
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