UK financial conditions provide tailwind amid fiscal uncertainty – The Real Economy Blog

Report on UK Financial Conditions and Alignment with Sustainable Development Goals

This report analyses the current financial conditions within the United Kingdom, assessing their impact on the real economy through the framework of the United Nations Sustainable Development Goals (SDGs). It identifies a significant disconnect between favourable financial market indicators and lagging real economic performance, particularly concerning targets for sustainable growth and decent work.

Analysis of Financial Conditions and Sustainable Economic Growth (SDG 8)

Current Financial Landscape

Financial conditions in the UK present a positive outlook for growth, supported by a robust financial sector. The RSM UK Financial Conditions Index is currently at 1.4 standard deviations above neutral, its highest level since 2014, indicating low levels of priced-in risk and an increased potential for investment. This environment is further supported by several factors:

• Anticipated monetary policy easing, with a potential 25-basis-point rate cut by the Bank of England.
• Speculative investor behaviour and the strong performance of technology-related industries.
• Normally functioning fixed income markets, with gilt and corporate bond returns remaining attractive compared to other developed economies.

These conditions create a potential tailwind for economic activity, which, if channelled correctly, could support progress towards SDG 8 (Decent Work and Economic Growth) by fostering investment and innovation.

Disconnect with Real GDP Growth

Despite favourable financial conditions, the real economy exhibits signs of stagnation, challenging the achievement of SDG 8. Key indicators highlight this disparity:

1. Slowing Growth: Real GDP growth has decelerated, failing to surpass the 2% benchmark for developed economies since the post-pandemic recovery. The UK’s potential real GDP growth rate is estimated to have fallen to approximately 1.5% annually due to low productivity.
2. Weak Labour Market: Hiring has slowed, directly impacting the “decent work” component of SDG 8.
3. Fiscal Uncertainty: Uncertainty surrounding future fiscal policy, including the upcoming budget proposal, weighs on real economic activity and investment decisions.

This disconnect suggests that the benefits of a buoyant financial sector are not translating into broad-based, sustainable economic growth or job creation for the wider population.

Market-Specific Analysis and SDG Alignment

Equity Market Performance and SDG 10 (Reduced Inequalities)

The UK equity market, particularly the FTSE 100, has experienced a remarkable five-year run, rising at a 20% yearly pace. However, this performance is largely attributed to factors that may not align with domestic sustainable development objectives.

• Global Influence: The returns of FTSE corporations, many of which are multinational, often reflect the global economy rather than domestic conditions.
• Speculative Investment: Elevated equity markets are partly a product of speculative behaviour. While necessary for growth, excessive speculation can lead to asset bubbles, posing a risk to financial stability and potentially exacerbating wealth disparities, which runs counter to the aims of SDG 10 (Reduced Inequalities).

Bond Market Normalization and SDG 16 (Strong Institutions)

The UK fixed income market is undergoing a process of normalization following the recent inflation shock. The Bank of England’s policy adjustments have allowed the front end of the yield curve to drop, while concerns over inflation and public debt (120% of GDP) influence long-term rates. This normalization is critical for ensuring the stability and predictability of financial institutions, a cornerstone of SDG 16 (Peace, Justice, and Strong Institutions). Key observations include:

1. Return of Risk: Investors are again requiring higher rates to compensate for inflation risk, marking a return to more conventional market dynamics.
2. End of Zero-Interest Rates: The move away from zero-interest-rate policies helps correct financial distortions and provides investors with stable alternatives to speculative markets.
3. Attractive Corporate Bonds: The UK corporate bond market remains an attractive option for investors, offering a stable channel for corporate financing that can be directed towards sustainable innovation and infrastructure, aligning with SDG 9 (Industry, Innovation, and Infrastructure).

Currency Market Dynamics and SDG 17 (Partnerships for the Goals)

The pound sterling remains weaker than its pre-Brexit norms but benefits from high relative interest rates. Its gradual appreciation and reduced volatility signal an economy that has weathered significant external shocks. This stability enhances confidence in the UK’s political and economic framework, which is essential for fostering reliable international partnerships and maintaining stable global financial flows, as envisioned in SDG 17 (Partnerships for the Goals).

Conclusion

The UK’s accommodative financial conditions are predominantly a result of an elevated and speculative equity market rather than foundational stability in the real economy. This creates a critical challenge for sustainable development, as financial gains are not translating into the inclusive and sustainable growth required to meet SDG 8 targets. Future fiscal and monetary policy must focus on bridging this gap by incentivizing productive, long-term investment in the real economy to ensure that financial strength supports decent work, reduces inequality, and builds a resilient economic future for all.

Analysis of Sustainable Development Goals in the Article

1. Which SDGs are addressed or connected to the issues highlighted in the article?

The article primarily addresses issues related to economic performance, financial stability, and policy-making, which directly connect to the following Sustainable Development Goals (SDGs):

• SDG 8: Decent Work and Economic Growth: The core of the article revolves around the UK’s economic growth, or lack thereof. It discusses real GDP growth rates, productivity levels, and employment trends (“hiring has slowed”). The entire analysis of financial conditions, investment, and monetary policy is framed in the context of its impact on achieving stable and sustainable economic growth.
• SDG 17: Partnerships for the Goals: This goal includes targets related to finance and systemic issues, specifically enhancing global macroeconomic stability. The article’s discussion of public debt, inflation, interest rate normalization, and the stability of financial markets (bond, equity, currency) directly relates to the goal of maintaining a stable macroeconomic environment, which is a prerequisite for sustainable development.

2. What specific targets under those SDGs can be identified based on the article’s content?

Based on the article’s detailed economic analysis, several specific SDG targets can be identified:

1. Target 8.1: Sustain per capita economic growth in accordance with national circumstances.
   • The article is fundamentally concerned with the UK’s economic growth performance. It explicitly states, “The UK economy decelerated this year, growing at 1.7% and 1.4% yearly rates in the first and second quarters. Real gross domestic product growth has not cracked the 2% benchmark rate for developed economies.” This directly addresses the challenge of sustaining adequate economic growth.
2. Target 8.2: Achieve higher levels of economic productivity through diversification, technological upgrading and innovation.
   • The article identifies low productivity as a key constraint on the UK’s economy. It notes that “because of the low level of productivity, the UK economy’s potential real GDP rate has fallen somewhere in the range of 1.5% per year.” This highlights productivity as a central issue for economic performance.
3. Target 17.13: Enhance global macroeconomic stability, including through policy coordination and policy coherence.
   • The article analyzes several components of macroeconomic stability. It discusses the “2021-22 inflation shock,” the need for “normalizing of rates” by the Bank of England, and concerns over public debt, which “reached 120% of GDP.” This focus on managing inflation, debt, and monetary policy to create a stable economic environment aligns perfectly with this target.

3. Are there any indicators mentioned or implied in the article that can be used to measure progress towards the identified targets?

Yes, the article mentions several specific economic data points that serve as direct or implied indicators for the identified targets:

• For Target 8.1 (Sustain economic growth):
  • Indicator 8.1.1 (Annual growth rate of real GDP per capita): The article provides the core data for this indicator by stating the UK’s “Real gross domestic product growth” was at “1.7% and 1.4% yearly rates.” This is a direct measure of economic growth.
• For Target 8.2 (Achieve higher productivity):
  • Indicator 8.2.1 (Annual growth rate of real GDP per employed person): While not providing a specific figure, the article’s statement about the “low level of productivity” directly implies that this indicator is being monitored and is a cause for concern, serving as a qualitative measure of progress (or lack thereof).
• For Target 17.13 (Enhance macroeconomic stability):
  • Indicator: Public debt as a proportion of GDP. The article explicitly states, “By the end of last year, public debt reached 120% of GDP.” This is a key metric for assessing fiscal stability.
  • Indicator: Inflation Rate. The article refers to the “2021-22 inflation shock” and the “lingering effects of inflation,” indicating that inflation is a key variable being managed to ensure stability.
  • Indicator: Policy Interest Rates. The article details the Bank of England’s actions, noting it “has cut its overnight policy rate from its high of 5.25% to 4%,” which is a primary tool for managing macroeconomic conditions.

4. Summary Table of SDGs, Targets, and Indicators

Source: realeconomy.rsmus.com