Podcast Summary: "Why the UK May Be Poised for a Surprising Rebound"
Hosted by Morgan Stanley
Release Date: May 2, 2025

In the May 2, 2025 episode of Morgan Stanley's "Thoughts on the Market," hosts Andrew Sheats, Head of Corporate Credit Research, and Bruno Skaraka, Chief UK Economist, delve into an in-depth analysis of the United Kingdom's economic landscape. Contrary to prevailing market pessimism, the discussion sheds light on reasons why the UK might be on the brink of an unexpected economic resurgence. This summary encapsulates the key points, discussions, insights, and conclusions presented during the episode.

1. Context: Recent Challenges in the UK Economy

Bruno Skaraka opens the conversation by outlining the multifaceted challenges that have beleaguered the UK economy over the past several years.

• Brexit Negotiations (2016-2020): The protracted and uncertain Brexit process significantly dampened business confidence, leading to restrained capital expenditures.

  "[...] elevated uncertainty kept the lid on business CapEx in 2020." [00:54]

• COVID-19 Pandemic: The onset of the pandemic in 2020 introduced lockdowns and global disruptions, further straining economic recovery efforts.

• Supply Chain Disruptions & Energy Shock (2022): Post-pandemic supply chain issues were compounded by a European energy crisis in 2022. Notably, the surge in natural gas prices in the UK was twice as impactful on growth compared to the 1970s oil price shock.

  "[...] the natural gas price surge in the UK was twice more of a growth compared to the 1970s oil price shock." [00:54]

• Monetary Policy Responses: In response to soaring inflation, the Bank of England aggressively raised interest rates above 5% and has been slower than its international counterparts to reduce policy restrictiveness.

  "the bank of England had to hike interest rates to cap the inflation surge and they went to above 5%..." [00:54]

These cumulative factors have culminated in a notably weak post-COVID recovery for the UK economy, marked by subdued growth and persistent inflation.

2. Current State: Weak Recovery and Economic Indicators

Andrew Sheats and Bruno Skaraka further dissect the current economic indicators that have painted a bleak picture for the UK:

• Growth and Inflation:

  "Growth was pretty soft, inflation was still high because inflation was high." [02:10]
  The UK has grappled with low growth rates and high inflation, exacerbated by tight monetary policies and external uncertainties, such as adversarial US trade policies under the Trump administration.

• Labor Market and Fiscal Policy:
  The UK government's decision to hike payroll taxes in the October budget aimed at balancing the books has led to subdued sentiments in the labor market. Despite these measures, the labor market has fared slightly better than anticipated. Additionally, energy inflation forecasts have surged, prompting the Bank of England to adopt a more cautious stance in early 2025.

  "the government faced some pretty tough decision in the October budget and they hiked a tax, a payrolls tax really..." [02:41]

• Trade Dynamics:
  As a small open economy, the UK is highly sensitive to global growth dynamics. Services exports, particularly high-value white-collar services to the US, have been a bright spot, growing by 50% between 2019 and 2023. However, slowing growth in the US and Eurozone has necessitated downward revisions to the UK's GDP forecasts by approximately 30 basis points.

  "services exports to the us, the kind of value added white collar services exports which rose between 2019 and 2023 by 50%." [03:20]

3. Morgan Stanley's Future Outlook: Reasons for Optimism

Despite the current challenges, Morgan Stanley maintains a cautiously optimistic outlook on the UK's economic future, attributing this stance to several key factors:

• Relative Trade Resilience: Compared to the Eurozone and the US, the UK's trade-related GDP revisions remain less severe, positioning the UK as a potential relative winner amid shifting global trade policies.

  "the trade related revisions in the UK are still less than what our colleagues in the euro area and the U.S. had undertaken..." [04:02]

• Inflation Prospects: Morgan Stanley anticipates that inflation in the UK will decline more rapidly than initially expected by both the Bank of England and the markets. Enhanced commodities prices are expected to drive this decline, with domestically generated inflation projected to slow sharply next year as wage growth stabilizes between 3% to 3.5%, aligning with inflation targets.

  "inflation can come down faster than both the bank of England and the market expected..." [04:02]

• Monetary Policy Adjustments: The Bank of England is projected to implement significant interest rate cuts, totaling approximately 125 basis points between May and November 2025. The terminal rate is expected to decrease to between 2.5% and 3.75%.

  "the bank of England should be able to cut more than the markets expect... terminal rate could fall to as low as 2 and 3/4." [04:02]

• Fiscal Policy Improvements:
  Recent fiscal measures have exceeded market expectations, with borrowing increases lower than anticipated. Deficit projections indicate a reduction from around 4.8% of GDP this year to 3% over the next three years, with the debt-to-GDP ratio stabilizing around 100%.

  "deficit projections... to fall from around 4.8% this year to 3% over the course of the next three years." [04:02]

• Enhanced UK-EU Relations:
  In response to evolving US trade policies, the UK government is pursuing a closer trade relationship with the EU, aiming for a "trade reset." Initiatives include improving trade in food and goods and integrating UK defense companies into the European Defence Program. The upcoming summit on May 19 and the 2026 revision of the Trade and Cooperation Agreement are pivotal in this strategy.

  "the UK government... is looking for a closer relationship with the eu, or rather a trade reset with the eu." [04:02]

4. Investment Implications: Shifting Perceptions and Opportunities

The discussion transitions to the strategic implications of the UK's improved economic outlook for investors:

• Currency and Stock Market Performance:
  The British pound has appreciated against the dollar, and the UK stock market has risen by approximately 5% in 2025, outperforming the declining S&P 500.

  "markets are anticipatory... you've already seen the British pound... do quite well this year." [06:44]

• Stock Valuations:
  UK stocks, though concentrated in traditionally slower-growing sectors, present attractive valuations. Compared to the US stock index trading at around 21 times next year's earnings, the UK market trades at under 13 times, offering a less demanding entry point for investors.

  "the US stock index trades at about 21 times next year's earnings... the UK stock market trades a little bit under 13 times next year's earnings." [06:44]

• Bond Market Potential:
  Should the Bank of England enact more substantial rate cuts than the market anticipates, the UK bond market could become increasingly attractive, offering high yields in a favorable monetary environment.

  "if the bank of england does cut interest rates more than the market expects... that could be pretty supportive for the UK bond market." [06:44]

5. Conclusion: A Rebalanced Perspective

The episode concludes with a reaffirmation of Morgan Stanley's optimistic stance on the UK's economic prospects. Bruno Skaraka emphasizes the foundational strengths and strategic adjustments that could catalyze a rebound, while Andrew Sheats highlights the already positive market signals and potential investment opportunities. The hosts encourage listeners to reassess the UK's economic narrative beyond recent adversities, suggesting that the country's trajectory may be turning towards stability and growth.

Notable Quotes:

• "the natural gas price surge in the UK was twice more of a growth compared to the 1970s oil price shock." – Bruno Skaraka [00:54]

• "inflation can come down faster than both the bank of england and the market expected..." – Bruno Skaraka [04:02]

• "the US stock index trades at about 21 times next year's earnings... the UK stock market trades a little bit under 13 times next year's earnings." – Andrew Sheats [06:44]

• "if the bank of england does cut interest rates more than the market expects... that could be pretty supportive for the UK bond market." – Andrew Sheats [06:44]

This episode offers a comprehensive analysis of the UK's current economic hurdles and the strategic factors that could foster a surprising and robust rebound. By integrating macroeconomic indicators with fiscal and monetary policy insights, Morgan Stanley provides valuable perspectives for investors and stakeholders interested in the UK's market dynamics.