Episode Details

As the U.K. deals with a bout of market volatility, political transitions, and sticky inflation, how will policy makers and the Bank of England respond, and where might the U.K. economy be headed from here? Chief Cross-Asset Strategist Andrew Sheets and U.K. Economist Bruna Skarica discuss.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Morgan Stanley's Chief Cross-Asset Strategist. 

Bruna Skarica: And I'm Bruna Skarica, Morgan Stanley's U.K. Economist. 

Andrew Sheets: And on this special two part edition of the podcast, we'll be focused on the latest political, economic and market developments in the United Kingdom and how investors should think about the situation now and going forward. It's Thursday, October 27th at 2 p.m. in London. 

Andrew Sheets: So Bruna, the world's eyes have been on the U.K. over the last couple of months, not only because it's the world's sixth largest economy, but because it's been experiencing an unprecedented level of market volatility, and it also has had an unusually large amount of political volatility. So I think a good place to start this discussion is just taking a step back. How would you currently frame the economic challenges facing the U.K.? 

Bruna Skarica: Indeed, the level of volatility has truly been historic, both in the macro space, in the market and in politics. Now, in terms of what Prime Minister Sunak has on his tray coming into number 10, first let me mention the fiscal challenges. Chancellor Hunt, who's currently in number 11, has already reversed nearly all the measures from the mini budget, which was the catalyst of all this turbulence. Still, there is more to come. We think another £30 billion of fiscal tightening will be needed to stabilize debt to GDP ratio in the medium term. So more austerity, which of course, will be negative for growth. Now, this fiscal tightening, of course, comes in order to facilitate Bank of England's monetary tightening and help return inflation to the 2% target. The Bank of England has already hiked the bank rate to 2.25%, and we expect further hikes to come. So a lot of monetary tightening weighing on growth, too. And all of this is coming in the context of a very large external shock, that is the energy price move that has led to a spike in utility bills that the state is helping to counter, but that is weighing on UK's disposable income.

Andrew Sheets: Given all of these challenges, how do you think the Bank of England is going to react? They have an upcoming meeting on November 3rd, and they’re facing a backdrop where on the one hand the U.K. has some of the highest core inflation in the developed world, and on the other hand it has a number of these risks to growth which you just outlined. How do you think they try to thread that needle and what do you think they ultimately do?

Bruna Skarica: Indeed, the Bank of England has this year had a really complicated task at its hand. What started as the energy shock to inflation first impacting headline inflation, then spread on to pretty much every part of the consumer basket. The Bank of England we think has no choice but to tighten further from here. Chief Economist Pearl, in the aftermath of the mini budget, said that there will be a significant monetary response to the fiscal news and financial market volatility. As I mentioned, the mini budget was almost entirely scrapped, volatility subsided and so we think this significant response on November 3rd will come in the form of a 75 basis point hike. And we also see clear messaging from the Bank of England next week that this should be perceived as a one off level shift and that the pace of tightening will slow from December, as a lot of monetary t