United Kingdom
Defying a hard landing
Strengths
- High trade balance surplus on services
- Healthy banking sector
- Diversified export structure
- Friendly business environment
Weaknesses
- Very high twin deficits
- Lower economic attractiveness post Brexit
- Low productivity growth
- Decreasing long term per capita income
Economic overview
Recession dodged, caution ahead
The UK’s economy is likely to have narrowly sidestepped a recession in 2023, though the economic outlook remains far from optimistic, reflected in subdued confidence among consumers and businesses alike. The external environment has been a recent drag, with exports remaining below prepandemic levels, an outlier among G7 countries. A bright spot has been the resilience of domestic demand, particularly from consumers buoyed by significant savings amassed since the pandemic but also strong consumer credit growth, which builds up risks in the medium run. This buffer has propped up an economy that leans heavily on private consumption amid a tough international environment, helping it surpass its prepandemic real GDP by close to 3%. Moving ahead, this domestic cushion may thin, undermined by falling real wages over 2022-23 and negative wealth effects, pushing consumers to save more. While we expect the UK to avoid a full-blown recession, GDP growth will remain low at +0.6% in 2024, followed by 1.5% in 2025.
While inflation is gradually trending downwards, it continues to linger significantly above the BoE’s target and a return to below 2% is not expected before 2025. This sluggish decline stems in part from ongoing pressures in the services sector and a labor market that – despite signs of cooling – remains tight. Wage increases in the UK, which have surpassed those of peers, fuel the risk of a wage-price spiral. In the context of these ongoing inflationary pressures, it is anticipated that interest rates will stay higher for longer with no foreseen rate cuts until Q4 2024.
After a hiatus during the pandemic, corporate risk in the UK is back with a vigor as insolvencies are set to remain 30% above prepandemic levels. Unlike their European and American counterparts, which are grappling with diminishing margins, UK companies have showed resilience, managing to grow their margins even amidst the pressures of increasing labor costs. Nevertheless, this resilience is counterbalanced by a concerning trend of reduced corporate cash reserves. The outlook ahead is sobering, with forecasts suggesting a continued uptick in annual insolvencies in 2023 as well as 2024.
Excessive imbalances need to be reduced
Since Brexit, the UK economy has been exposed to negative structural changes. First, in 2022, labor shortages soared to record levels. Although these vacancies have subsequently decreased, they continue to exceed their long-term trends, indicating ongoing challenges in the labor market. Additionally, youth employment continues to be a concern, with the employment rate for those aged 18 to 24 significantly trailing behind that of other age groups.
Second, post-Brexit, the EU’s share of UK imports remains below prereferendum levels, continuing a longer-term decline. In 2022, China solidified its position as the UK’s largest single import market, accounting for a significant 13.4% of its total merchandise imports. The UK’s dependence on imports from outside the EU presents a potential risk to its production sector. This was exposed in 2021, when global supply shortages highlighted vulnerabilities in the global supply chain and pushed inflation above that of peers, underscoring the potential implications of the UK’s shift in import sources.
Third, the economy has accumulated high twin deficits, exceeding -4% of GDP, which coupled with fickle market confidence and elevated borrowing costs are expected to push the next government to switch to fiscal consolidation in the medium term. In the short term, however, the fiscal deficit is anticipated to remain wide, with the current government expected to maintain high spending levels in the lead-up to the 2024 election. In 2023, the Bank of England shifted from its cautious approach of the previous year, adopting an “aggressive, early hiker” stance. This strategic pivot was not only aimed at addressing persistent inflation but also at reinforcing the nation’s faltering currency. The UK economy is particularly vulnerable to fluctuations in foreign exchange rates, with around 50% of its import prices being influenced by currency dynamics, notably higher than in countries like France and Germany. This high sensitivity in import prices is in stark contrast to the export sector, where the benefits of a weaker currency are limited due to a substantially lower passthrough effect. These growth benefits are further reduced by the current international context of sluggish global trade growth, which is projected to modestly exit recession in 2024 (+3.3%). Despite a recent recovery, the GBP still remains below prereferendum levels, though there is some potential for further appreciation. It is expected that the loss of favorable EU trade terms will continue to weigh on exports in 2024, but this will likely be offset by reduced import costs, which will prevent the UK’s current account deficit widening significantly.
Strong business environment but weaker since Brexit
Political volatility may be on the horizon in 2024. Under Prime Minister Rishi Sunak, who assumed office in October 2022, the Conservative Party has made modest gains in opinion polls but still significantly trails the Labor Party. The next election, expected in late 2024, is likely to be a challenging one for Sunak and the Conservatives. Forecasts are currently pointing towards a Labor victory, with a narrow but absolute majority. A transition to their governance will likely bring an initial honeymoon period of public goodwill. However, maintaining this support will depend on their capability to effectively tackle the country’s economic and social challenges.
In this evolving political landscape, policy towards investment remains favorable and the UK maintains an overall probusiness policy stance. Despite the rise in corporate tax from 19% to 25% in 2023, the UK’s rate is still lower than that of the EU’s largest economies. However, Brexit has worsened the UK’s terms of trade, notably as foreign direct investment has adjusted on the downside and the sterling has suffered from a strong depreciation.
The UK continues to negotiate further trade agreements post-Brexit, seeking to strengthen its global trade network. A notable advancement is an anticipated Free Trade Agreement (FTA) with India, though negotiations remain ongoing. This effort is part of a broader strategy as the UK adapts to new trade dynamics outside the EU. A number of FTAs have been established in recent years, including with Australia (December 2021) and New Zealand (February 2023). In addition to these, the UK joined the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) in July 2023, linking it with an important Asia-Pacific trade bloc of 11 countries.
Ireland
A regular Eurozone outperformer
AA1
Low
risk for enterprises
Strengths
- Strong business environment
- Robust current account surplus
- Strong fiscal position
- English-speaking business location
Weaknesses
- Sensitive to external shocks due to high openness to trade
- High dependency on foreign investment
- High private debt
Economic overview
A regular Eurozone outperformer
Ireland has consistently outperformed other Eurozone countries, with growth rates of +6.2% over the past 30 years and +9.1% over the past 10 years. This impressive economic performance can be attributed in part to the expanding presence of multinational corporations (notably in the technology, pharmaceutical, chemical and financial sectors), which have become integral to the Irish economy, accounting for over 50% of GDP and employing approximately 10% of the labor force. However, 2023 showed the downside of this dependency, as the environment of higher interest weighed on global demand while consumers’ resilience has also reduced and dragged the country into a recession, to an estimated -2%. Looking to 2024, a modest +2.6% rebound in GDP is expected as these economic pressures should ease. While households’ saving rate is back to pre-pandemic levels, the tightness of labor market should provide limited support with nominal wage growth above 4% along a disinflationary trend (inflation expected to fall to 2% in 2024).
Moderate medium-run vulnerabilities
A key reason behind the sizeable presence of multinationals in Ireland has been its attractive low tax environment, which has lured substantial foreign investment. However, in 2022, Ireland introduced changes to the international corporate tax framework. These changes included the reallocation of profits of multinational companies across different states and an increase in the tax rate for large companies from 12.5% to 15%. This could mean that higher taxes on the domestic economy are needed as corporate tax revenue is the secondlargest single source of revenue, standing at more than half of the increase in total revenue since the Covid-19 crisis. On the positive side, the external account is strong: the current account surplus should continue to stay above 5% thanks to the recovery in global trade which should strengthen Ireland’s net exporter position.
In the medium run, Ireland’s trade structure remains a vulnerability in terms of the dependency on pharmaceuticals and computer services. In addition, in terms of destinations, export concentration is high as the US and the UK represent around 40% of total Irish exports. The strong presence of the multinational sector makes Ireland appear very vulnerable in terms of external debt but being part of the Eurozone makes it manageable. In addition, the rapid and strong global tightening in monetary policy has led to a correction in house prices as of mid-2023 which should continue into 2024 on the back of lower housing affordability and less support from the multinational sector.
The banking sector in Ireland is in good health with profitability being boosted by rising net interest margins and a strong deposit base. Net interest margin is close to 3% compared to 2% pre-pandemic. NPL ratio stands below 3% compared to close to 5% pre-pandemic, but an increasing trend is expected due to deteriorating households’ and firms’ balance sheets and higher borrowing costs. Household debt stands at 108% of net disposable income, above US levels, but 40pp below UK levels. Business insolvencies have returned to pre-pandemic levels and should increase by +12% in 2024, to 760, highest level since 2018.
The fiscal balance should continue to register a small surplus in the coming two years. Additionally, public debt has been kept under control, decreasing from pandemic peaks of 58% of GDP to around 43% in 2024, presenting an overall strong fiscal position. To further stabilize future public finances against the volatility of corporate tax receipts, the government is in the process of establishing a sovereign wealth fund. This fund aims to strategically invest the windfall revenues generated from corporate tax revenues. The size of the fund is expected at EUR100bn by 2035 with a rate of return of close to 4%. A second fund of EUR14bn is planned which intends to finance green infrastructure but also support catch-up on targets to cut greenhouse gas emissions.
Business environment and political developments
Ireland’s business environment is notably strong, scoring highly in regulatory quality, rule of law and corruption control. Ireland also has a very well-educated labor force and enjoys a significant openness to foreign trade and FDI. Starting a business, protecting minority investors, paying taxes and resolving insolvencies are ranked at the top among other OECD high-income countries. However, going forward, the introduction of the minimum global corporate tax reform is expected to modestly dampen Ireland’s attractiveness, particularly for multinationals.
The 2020 general elections resulted in a three-party governing coalition (Fianna Fail – center-right, Fine Gael – center-right and the Green Party – center-left) and is the most fragmented parliament in recent history. Under the terms of the coalition agreement, Leo Varadkar of Fine Gael became Taoiseach in December 2022, following a rotational arrangement with Fianna Fáil. This transition of power occurred smoothly, but with the general elections approaching (due by March 2025), there are expectations of potential challenges within the coalition, as parties may reassess their positions if they believe this will play better with their voters.
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