The UK economy - as viewed by Barclays experts

The UK economy has suffered the deepest recession and the slowest recovery in almost 100 years. Now, finally, it is beginning to regain its strength. This year, our researchers expect it to expand by about 3 per cent. This is likely to be the fastest growth of all the world’s leading economies in 2014. It is also a big improvement on last year’s 1.7 per cent.

Economic data recording optimism and output are improving quickly. For example, manufacturing output is around 4 per cent higher than a year ago, and the fastest annual rate of growth since 2011. British employers are raising the salaries they offer to new permanent staff at the fastest rate in almost seven years, and the strong labour market is making households more optimistic. Consumer confidence has also reached a 5 year high, which bodes well for retail sales and spending on services.

Consumption has been the main force behind the UK’s growth over the past year. It accounts for 60 per cent of the economy. However, two other key drivers of growth are now improving. One is business investment: companies spending money on equipment. In the final quarter of 2013, this was almost 9 per cent higher than a year before, and it has now risen for four quarters in a row. The other is exports, where analysts expect the UK to benefit from the recovery of the Eurozone, its biggest export market.

You can read more about European economy in our article “High risk bargains lure investors to Europe

Why UK inflation seems to be under control

When growth accelerates, inflation can also rise quickly as businesses raise prices and consumers demand higher wages. To prevent inflation from getting out of hand, central banks can raise interest rates. This encourages people and businesses to spend less and save more. However, it can also lead to slower growth. Fortunately, inflation does not seem to be an immediate problem in the UK today.

The annual rate of consumer price inflation (CPI) has fallen under the government’s target of 2 per cent for the first time in over four years, and Barclays researchers believe it could stay there for some time. Commodity prices have fallen back recently, energy suppliers are cutting their bills and a supermarket price war is expected to drive down the cost of living even further.

The other widely watched gauge of annual inflation, the retail price index (RPI), is currently around 1 per cent higher than CPI because it includes mortgage interest payments. However, it too has declined in recent months.

Another trend acting against inflation in the UK is the strength of the pound. A strong currency makes imports cheaper, and sterling is at a 5 year peak compared with the currencies of the UK’s main trading partners. Meanwhile, average earnings are only increasing very gradually, by around 1.5 per cent year-on-year.

All of this means the Bank of England is unlikely to feel much pressure to raise interest rates in the short term. Indeed, Barclays researchers do not expect the UK base rate to rise above 0.5 per cent – the historically low level it has maintained since March 2009 – until at least next spring.

Why the UK housing market remains hot

Low interest rates are good news for the economy as a whole and especially for the housing market. They have helped boost the price of the average UK home by over 5 per cent in the past year, along with a general shortage of housing across the country and an increased willingness to lend among mortgage providers. The average British house is now worth around £170,000, compared with £182,000 at the peak of the last boom.

This recovery is being led by London, where prices have risen by over 13 per cent in the past year and the average house now costs £414,000. In other regions and major cities, price increases have been much more subdued. For instance, prices in Birmingham and Manchester, two key business centres, have seen annual increases of around 3 per cent.

One of the main reasons for London’s exceptional performance is that it is seen as a “safe haven” by many international investors. Of all the houses sold for more than £1m in London since 2011, more than half were bought by people from outside the UK.

However, the tax rules on foreign ownership of UK property are tightening. For example, foreign companies that invest in UK property must now pay stamp duty of 15 per cent on properties worth £500,000 or more; before the latest UK Budget in March, this tax used to apply only to properties worth £2m or more. The tax does not apply to homes that are rented out, so it is likely that the supply of available rental properties will now increase – especially in London.

It is also worth noting that, as of April 2015, non-residents will have to pay capital gains tax (CGT) on any property they own in the UK. They are currently exempt. You can read more about this measure in our article ‘Could the new UK property tax affect you?’, although please note that Barclays does not give tax advice and you should seek independent advice tailored to your individual circumstances.

In spite of these negative factors for foreign investors, the UK housing market as a whole should continue to recover: mortgage approvals for new house purchases, which are a leading indicator for house prices, recently hit a six-year high. And that in turn will make households feel richer and encourage them to spend, boosting the economy further. With growth gaining speed, but interest rates not due to rise until 2015, the outlook for the UK economy as a whole has not been this positive since the boom years of the mid-2000s.

You can find out more about Barclays view of the UK economy by listening to our latest podcast


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