Episode Details

Despite news that the UK economy is set to slow due to uncertainty around US trade policy, our analysts Andrew Sheets and Bruna Skarica explain why they have a more optimistic outlook.

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----- Transcript -----

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Bruna Skarica: And I'm Bruna Skarica, Chief UK Economist at Morgan Stanley.

Andrew Sheets: Today we're going to talk about the United Kingdom and why, despite a downbeat outlook by many in the market, we remain more optimistic.

It's Friday, May 2nd at 2pm in London.

Bruna, it's great to talk to you again about the UK and not just because this is an unusual day in London where it's sunny and warm, and at the moment warmer than Los Angeles. You know, when discussing the UK, I do think you kind of need to take a step back. This is a country and an economy that's had a tough number of years where growth has been sub-trend, inflation's been higher, and a lot of assets have traded at a discount.

So maybe just to give some context, talk to us a little bit about the last couple of years in the UK and the challenges the economy has faced.

Bruna Skarica: Indeed, Andrew, I do think it's important to take a step back to appreciate just the amount of supply side shocks the UK has seen in recent years. First, between 2016 and 2020, of course, the country had to navigate Brexit negotiations. The elevated uncertainty kept a lid on business CapEx. In 2020, of course, as the rest of the world, we saw the lockdown and the pandemic. What followed were supply chain disruptions, and then, the European energy shock in 2022. I do want to zoom in on this final point because in its scale, the natural gas price surge in the UK was twice more of a hit to growth compared to the 1970s oil price shock.

We've also seen a fair share of volatile market moves, most notably around the mini budget in the autumn of 2022. On top of all of this, the Bank of England into these supply side shocks had to hike interest rates to cap the inflation surge. And they went to above 5 per cent and have recently been relatively slower in reducing policy restrictiveness than most of its peers.

So, when you tally all these factors up, it's really no surprise that the UK has seen an exceptionally weak post COVID recovery.

Andrew Sheets: And that's continued right into this year. You know, I remember a lot of conversations with global investors heading into 2025, and again, the sentiment around the UK was kind of downbeat. Growth was pretty soft. Inflation was still high. Because inflation was high, interest rates here were still quite high. And so, you really had this, you know, unattractive mix of weak growth, high inflation, tight monetary policy. And then you could throw onto that, this uncertainty around the U.S. and trade. And you had a Trump administration that was adopting a more adversarial policy towards trade and towards Europe, which the UK was getting caught up in.

So, you know – again, did I miss any of the challenges that the UK was facing, entering this year?

Bruna Skarica: No, I think that's a great summary. First, at the end of last year, of course, the government faced some pretty tough decisions in the October budget, and they hiked a tax – a payroll tax really – in order to balance the books, which created somewhat subdued sentiment around the labor market this year.

Now the labor market has been soft in the UK at the start of this year, but it did hold up a little bit better perhaps than the expectations from the end of last year. At the start of the year