How can we unlock UK growth?

John Robertson: Welcome to the Insight in 15. I'm John Robertson, and today I'm joined by Yael Selfin, who's a vice chair and chief economist here at KPMG in the UK. And we're going to be talking about the prospects for economic growth in the UK. So, Yael, thanks very much for joining me today.

Yael Selfin: Thank you for having me.

John: Okay, so I'm gonna start with a shameless plug for your new UK Economic Outlook Report, which should be out now. Tell us a little bit more about that and what it covers.

Yael: So, our latest Economic Outlook Report looks at monetary policy and, some of the dilemmas the Bank of England has at the moment in terms of the interest rate decision, as well as something that's very topical, looking at how you can help accelerate growth across different regions in the UK. 

John: Okay, well, we're going to talk about as much of that as we can in the 15 minutes we have. So, let's start with growth. We've got a new chancellor who's talked about turning Great Britain into Growth Britain, but Yael, what can we expect for the UK economy over the next year? Are there signs of growth?

Yael: So John, it's actually really interesting that the first half of the year, we had relatively strong growth already despite the crisis in Iran. The big question is what would happen in the second half of the year? And we're expecting the second half to be a little bit weaker. That is partially because we've seen the cost of energy now transmit more into household through the energy price cap. So household are going to fill that shock more in the second half, but we also seen tighter financial conditions and generally that realization that the crisis in Iran could last longer than what most people had anticipate is likely to put down on pressure on activity.

John: You mentioned the energy shocks we've been experiencing, and I got a bit of a shock when I went to fill my car up at the petrol station earlier this week. But what does that mean for the UK economy and inflation?

Yael: So the outlook for inflation is a little bit mixed. I'd say if you look at 2022 when we had another energy price shock, inflation went up significantly. This time round, we're expecting the increase to be more muted just because the economy is a little bit weaker, especially the labour market is weaker than previously, but we are expecting inflation to accelerate and reach around 3.5 in the final quarter of the year and pick it around 4% next year. Obviously, all will depend a lot on how that crisis in Iran evolves over the coming months. 

John: So I suppose this puts some decisions in the hand of the Bank of England around what it does with interest rates. I mean, it's just held them at 3.75%, but what do you think is gonna happen with interest rates looking forward?

Yael: Yeah, I mean, the Bank of England is under quite a lot of pressure to increase rates. If you look at the ECBs, the Fed, two of the other major central banks have already increased rates, but I think here we are in a slightly different position because the labour market, as I said, is relatively weak. We haven't really seen that increase in wage growth to compensate for that higher inflation given the weak labour market, and therefore there's less need for the Bank of England to step in. but nevertheless, it's very likely they will increase rates in November, and then maybe will be able to start cutting rates again in the second half of next year, but that would probably be the earliest we'll see them lowering rates, provided that inflation starts falling quite significantly next year.

John: What's all this mean for consumer confidence, Yael?

Yael: So, consumers, are now facing higher energy costs, household energy costs. So that is a burden. They're also seeing higher financing costs, or higher mortgage rates, et cetera. So all that is putting pressure, genuine pressure on consumers, wage growth, especially in the private sector, is relatively weak. So in terms of real increase in income, that is under pressure. That is not helping consumers.

Weaker labour market is also putting down pressure on consumers, but we've seen higher saving ratios, not just in the UK, but in other countries. So consumers generally are trying to save more, which means that they can smooth the spending patterns a bit more than previously, and they're a bit more careful with water spending. So I'd say for business leaders, they need to look at the cyclical part where we have a relatively weak consumer confidence, potentially in the short term, but also the longer term trends in changing consumer preferences that is probably more important. 

John: So in the short term, we have, slowing growth. We've got inflation going up. We've got consumers feeling the pressure. For businesses listening to this, what are the upsides?

Yael: So one of the things that we're extremely happy about and hope this will continue is the fact that business investment has been relatively strong. A lot of it is driven by technology and potentially the adoption of AI, but when you look at the impact on productivity at least, the numbers that we have at the moment are relatively broad based. So we have seen a pickup in productivity. We've seen stronger business investment. That's great news for the UK economy because that means its longer term growth could potentially be stronger as a result.

John: You mentioned AI there, and we love talking about AI here on the podcast. We've had a few episodes about that. One of the things that comes up is around organizations realising value and their return on investment. Do you have any insights for us, Yael, on when UK PLC can expect to get a return on its investment in AI?

Yael: So I would probably repeat what others have said, and I think that is really important. The thing with AI is if you really want to make it improve productivity significantly, you need to reshape the way your whole operation is done, and that's not easy to do, especially for large complex organization where they have to make that transformation while still working at full speed, if you like. So I think it is going to take longer, and it's going to be more challenging for businesses to make the full use and get the benefits out of AI, but I am extremely excited about it. I think the potential is very large, and especially in times where we're still grappling with a very longer trend of aging population, and an economy that is shifting towards services that are potentially less productive as a result, this is a major potential for us to boost productivity and prosperity for everyone in the UK. 

John: We've got the first budget of a new government coming up on the 28th of October. Actually, we've got Tim Sarson, who we both know well. For our listeners, he's our head of tax policy at KPMG UK. He's gonna be on in a couple of weeks, giving us his predictions for the budget, but I wanted to give you first bite of the cherry and say, what do you think we might see from the budget, and are we gonna see anything that's trying to incentivize growth in any way?

Yael: So just looking at the fiscal room to start with, what would the chancellor have? We would expect that higher interest rate in high yields to reduce a significant part of that headroom that the chancellor had, and that coupled with weaker growth will also potentially hit the OBR forecasts, which means that we will probably see the headroom half, at least half from the spring statement.

So my prediction, if you like, is that the chancellor will be quite careful with whatever additional investment he announced that will be financed by borrowing to make sure that it is quite clear that it can generate that additional growth for the economy. And then on day-to-day spending, I think any additional spend will have to probably be financed by tax increases with some scope for reduction in current spending, but that will be very difficult to make. One option that could potentially make quite a big difference when we look at productivity and trying to make more equal distribution of growth across the country would be to abolish stamp duty on prime residence. And that's because it can help alleviate some of the pressures on the housing market, as well as make it easier for talent to move across the country much more than what we have at the moment.

John: Beyond the budget, I guess itself, there's been talk about a 10-year plan. What options do you expect to see or what options are open to the government to put into that 10-year plan to drive growth?

Yael: There's a lot of disincentives in the tax system for people to work more or for entrepreneurs to invest more in the UK. So I would simplify it and try and remove a lot of the disincentives that we have there. Then there's a regulatory framework, for example, potentially cutting some of the red tape on housing and new housing developments could help. And then, yeah, I'd say there's not a lot of money for the government, so they need to think of alternative ways to boost growth. A clear agenda and strategy helps businesses in terms of the certainty and clarity for longer-term investments, so that is also very important.

And in that sense, a 10-year plan is a good step. It just needs to be clear where they're heading, and it needs to be pro-growth. You cannot really get stronger growth in the UK economy or any economy, really, just by spending more public money. You really need to bring the private sector with you. So a plan that does that is really what you need. One of the things I would add is we need cheaper energy because that is really important, not just for our traditional manufacturing sector, but also for new sectors like technology and AI. We need cheaper energy and more resilient supply. 

John: One thing that this new government has talked about a lot is the idea of regional growth, regional investment. What can we expect there, Yael?

Yael: You need something that is very strategic and the understanding that whatever you do will take a long time to actually see the fruits of it because it is a long-term process. It's not something you can fix in a year or two. I'd say one of the key thing you need above everything else is a very strong local government that you can devolve powers to, that can actually develop and execute a strong strategic plan for the region. That is the most important thing.

John: I think we're almost up on time. So I'm going to ask one more question, which is a question we put to all our guests, which is what's your one key takeaway for our listeners?

Yael: My one key takeaway would be that these are extremely exciting times. There's loads of disruptions, different shocks happening, different governments coming and going, but you really need to now more than ever focus on the big issues, the big themes, what's really driving the growth for you and where the big risks are. 

John: Well, that's our 15 minutes up. Thanks for joining us today, Yael. Hope you've enjoyed the episode. Please do take a look at the full UK economic outlook report. There's a link in the description for this episode. And please do like and subscribe to the podcast. You'll be able to find it on YouTube, Spotify and Apple podcasts. We'll be back in two weeks when we'll be talking to Tim Sarson, our head of tax policy here at KPMG in the UK for his predictions for the budget. Hope to see you then on the Insight in 15.