JUNE 2024
Does the chart below help to explain why Rishi Sunak called the General Election several months earlier than expected?
The Citigroup Economic Surprise Index gauges how actual economic data compares to expectations. When the line is rising it means indicators are performing better than expected and vice versa.
It has rebounded strongly since late February, suggesting the UK economy is currently faring better than initially forecast. GDP growth returned to positive territory in Q1, with its fastest rate since 2021, and inflation continues to ease.
It’s possible that the Prime Minister has called the 4th July election on the back of this economic improvement, but it’s unlikely.
Even though recent data points have surprised on the upside, overall economic activity remains weak and above-target inflation is still fuelling a cost-of-living crisis for vast swathes of the electorate.
There is unlikely to be an economic feel good factor amongst a large portion of the voter base, which is why the Conservatives currently trail Labour by over 20 points in the polls.
The UK consumer price index (CPI) has declined sharply from its 11.1% peak in October 2022 (blue line) thanks largely to a fall in energy prices, slower food inflation and weaker consumer demand. It registered 2.3% in April, a 3 year low.
The Office of Gas and Electricity Markets (Ofgem) has announced a further reduction in the energy price cap from 1st July, fuelling hopes that headline consumer prices will fall further during the second of the year.
However, the chart below suggests CPI readings will soon trend higher again.
It maps the producer price index (PPI) against CPI with the former tending to lead by 2-3 months. The PPI index started to rebound in February, having spent a few months in negative territory, suggesting CPI will also increase over the summer.
Encouragingly, the rise in both PPI (red line) and CPI is likely to be curtailed by the lower energy price cap, meaning a repeat of the 2021-2022 surge to double-digit inflation rates is a low probability outcome.
UK consumer confidence has rebounded strongly from its late 2022 record low, hitting a 2-year high in May. It should continue to rally over the next couple of months because the reading has historically improved during General Election campaigns.
The upturn in confidence is, however, at odds with the consumer spending data, which remains lacklustre.
On the one hand this isn’t unusual. Consumer confidence indicators are typically survey-based and often what respondents say they are feeling differs vastly from how they behave.
On the other hand, the divergence likely reflects the challenging economic backdrop.
Spending on non-essential items has been sluggish for some time, whereas purchase of non-discretionary goods and services (e.g. fuel and food) has been solid, mainly due to higher prices.
This means overall consumer expenditure is holding up reasonably well. It’s just that most households are spending a disproportionate amount on what they need, not what they want.
There have been five Labour Prime Ministers since World War II, covering eight “red” Governments with half of those stemming from the Blair/Brown era. Betting markets and the opinion polls suggest it is a near-certainty that Sir Keir Starmer will soon become the sixth.
However, if recent political events are anything to go by, the result will be a lot closer than expected. If so, this is likely to cause volatility in foreign exchange markets as we head towards 4th July; sterling tends to bear the brunt of investor uncertainty, much more so than the UK equity and bond markets.
Assuming the bookies and polls are correct, the downside for the pound appears limited. It is already trading around a generational low and a putative Labour administration will be aware that any attempts to further expand the yawning fiscal deficit will be frowned upon by the gilt market.
That said, even a convincing Labour victory is unlikely to spark a sustained rally, given the sluggish economic backdrop and the Bank of England’s desire to start cutting rates later this year.
In short, brace for some volatility in sterling over the coming weeks, but the election is unlikely to spark a major longer-term move.
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