Is the UK economy more like the US or the euro zone?

>> A focus will be on UK monetary policy

It might not be an important distinction most of the time, but it could be of significance now as the Bank of England ponders whether to follow the imminent rate cuts from the ECB, or hold out as the Fed is doing.

It is easy to see why the UK is often characterised as being more like the US than other developed European nations. Factors such as the weaker social security safety net in the UK, the size of the financial sector, and much more, contribute to the sense that the UK is economically more aligned to the US and perhaps politically as well, given the alleged ‘special relationship’ with the US that UK politicians are keen to cite and, of course, Brexit.

In theory, at least Brexit should make the UK more like the US and less like other EU countries. The UK now cuts its own trade deals, for instance, and does not have to do so under the umbrella of the EU. But has this meant that the supposed eurosclerosis foisted on the UK has been replaced by the relative dynamism of the US?

Unfortunately, not. While the US has been getting on with a trade war that has seemingly served the economy well, or at least not damaged it, the UK has engaged in a trade war with itself via Brexit. Another point that has become particularly apparent in recent years is that the US’s financial dominance, which comes through the global role of the dollar and the safe-asset quality of the treasury market, has allowed the government to pursue the sort of fiscal largesse that the UK can only dream of.

This was shown in very stark terms back in September 2022 when the fiscal dreams of former Prime Minister Liz Truss were crushed by the harsh reality that the gilt market is not the treasury market and the pound does not have the status of the dollar. This is one reason why the government-in-waiting, the Labour Party has not made any dramatic fiscal pledges and, even when it has promised action, such as net-zero financial commitments, it has had to backtrack.

All of this would seem to suggest that, for all its efforts, the UK is stuck with a sclerotic economy that remains more like other developed EU countries and less like the US. In fact, there’s a good case to be made for the fact that things have gotten even worse for the UK since Brexit as it falls behind even the labouring EU economies. Surely, then, this means that the Bank of England should follow the fast-acting ECB and cut rates soon, while eschewing the patience that the Fed seems to be showing. Interestingly, for much of this year the market has not just thought that the BoE would cut rates after the ECB, but after the Fed as well.

>> What will be beneficial for the pound?

“We have long argued that this was incorrect and, more recently, the position has changed with expectations for the start of the BoE’s easing cycle lying between that of the ECB and the Fed. It has to be said that the bulk of this adjustment has been because the market has pushed expectations for Fed rate cuts back, rather than pull forecasts of BoE rate cuts forward”, said Steve Barrow, Head of Standard Bank G10 Strategy.

Nonetheless, Steve Barrow thinks the market is better calibrated at the moment. Could the UK start to come forward even more, perhaps to put rate cut expectations on a par with the ECB? He thinks it unlikely. For while annual inflation could dip under the target soon, the UK does not share the, relatively modest, wage growth we see the euro zone and, even more damaging, does not share the robust productivity growth that the US has been experiencing. Steve Barrow suspects that the rate-cut cycle won’t start as soon as the ECB, which should be in June, but will be ahead of an assumed September start from the Fed. In other words, the August meeting is the one we’d target for the first rate cut.