The UK and US economy – are they still on track for a soft landing?

As the global economy continues to navigate the aftermath of the pandemic and geopolitical tensions, the focus has shifted to how major economies are managing their recoveries.

The UK and the US, two of the world’s largest economies, are both striving for a “soft landing” – a scenario where economic growth slows to a sustainable pace without tipping into recession.

What is the current state of play?

In the UK, recent data suggests a cautiously optimistic outlook. The latest Gross Domestic Product (GDP) figures released by the Office of National Statistics (ONS) on Thursday, showed the economy had grown by 0.6% in Q2, following a 0.7% rise in Q1. The International Monetary Fund (IMF) has upgraded its growth forecast for the UK, predicting a modest 0.7% growth in 2024, with further strengthening expected in 2025.

US GDP increased by 2.8% in the second quarter of 2024, following on from 1.4% in Q1. This is the eighth consecutive quarter that the economic powerhouse has managed positive growth on the previous three months. The last time the US economy had negative quarter-on-quarter growth was two years ago.

GDP is a lagging indicator, so it’s always slightly behind reality. But there are other indicators that can act as a good bellwether for the state of the economy, and what direction it may be heading in.

The labour market is softening

The US and UK labour markets had been looking similar. There had been strong jobs growth, an excess of job vacancies, rapid inward migration by job seekers, and a large pool of people at home not seeking jobs. Pay rises were strong, and a concern to the Federal Reserve (Fed) and the Bank of England (BoE).

The latest job figures show a divergence between the two.

The US job market is slowing. In July unemployment rose from 4.1% to 4.3%, increasing by 352,000 to 7.2 million. Labour participation was at 62.7%. Private sector earnings rose 3.4% annualised. These figures look sufficiently good to allow the Fed to make a cut in interest rates as markets are expecting.

The rise in the unemployment rate sparked fears across the market and also triggered the “Sahm rule”, which has historically had a 100% success rate in calling recessions. However, the unemployment rate rose due to an increase in the size of the labour force, not due to layoffs. We haven’t seen the rule triggered in this manner before, so we remain wary of its predictive powers in this case. Employment data can also be erratic, and the month of July saw a number of layoffs due to weather-related issues.

In the UK, unemployment is down to 4.2% from 4.4% on the three-month figures, and as low as 3.6% for June as a single month. Pay growth slowed but was still at 5.4% which isn’t at a level compatible with the 2.0% inflation target if it persists. Labour force participation was at 74.5% (not comparable with US figures as the UK excludes the over 64s but US doesn’t).

The UK has 9.5 million people of working age not in employment, but only 1.8 million of these might want a job. 2.5 million are students, 1 million have taken early retirement, and 1.7 million are looking after family at home.

Inflation – moderating, but slowly

The latest inflation data saw UK CPI rise from 2.0% to 2.2%, but below expectations. The government preferred CPIH (including housing costs) climbed to 3.1%, with a 7.0% increase in owner occupied housing costs boosting it. The sticky service sector inflation fell from 5.7% to 5.2%, which will please the BoE, but it’s still uncomfortably high.

The general market view is the BoE will be able to make another 25bps rate cut later this year, but it should take further slowing wage growth for this to be well based.

The new Labour government is currently settling a number of long-outstanding public sector pay disputes by offering considerably higher salaries. Junior doctors are set to receive a 12.0% per annum pay increase and train drivers will receive a 15.0% pay rise over three years. The national minimum wage has also been lifted by 10.0%. Markets will need to watch to see if this has a knock-on effect to private sector settlements.

The latest US inflation figures were released this week, showing a 2.9% year-on-year increase in prices, just below expectations. Most of this increase was due to a pick-up in housing costs. Energy prices were unchanged in the month, while food price rose by 0.2%. Core services

This has prompted speculation that the Fed will announce an interest rate cut when it next meets on 18 September. Forecasts are predicting a 40.0% likelihood of a 50bps cut, and 100% chance of a 25bps rate cut. We sit in the latter camp.

Read more: the market sell off – what it means for asset allocation

Other factors to consider

• Mortgage rates – US mortgage applications rose last week by 16.8% following a 6.8% rise in the previous week, and currently sit at their highest level since January 2023. This is a reaction to the rally in bond markets at the start of August which resulted in a sharp decline in yields of long-dated treasuries, and therefore lower mortgage rates. It’s one to watch to see the impact it has on US household finances and how it feeds through into consumer spending.
• Retail sales – These act as a key indictor of consumer spending and the overall health of the economy.
• The US retail sales report for July was released this week, showing strong growth with an 1.0% increase in sales. This figure came in much stronger than the expected 0.3% rise, highlighting the continued strength of the US consumer and helping to erase some of the recession fears.
• UK retail sales in July were up 0.5% month-on-month, buoyed by the late arrival of summer and sporting events. However, the figures narrowly missed the market consensus of 0.7%. Department stores and sports equipment were the main contributors to the rise, as consumers took inspiration from the Euros 2024 and the Olympic games.

Our view

We think the UK and US are still on track to navigate a soft landing – a world where inflation is under control, the economy is still growing, and most people still have jobs.

The challenge remains for both central banks to land the timing of interest rate cuts. They will continue to be data dependent in determining the size, timing and numbers of interest rate cuts.

The market is still pricing in that the Fed will deliver 100bp of cuts this year to see Fed funds rate return to a “neutral” level of 3.0-3.25% by mid-2025. Here in the UK, two or three rate cuts of 25bps are expected over the next year. We think the market has become too optimistic on the magnitude of rate cuts in the US.

Equity and bond markets will likely remain volatile, as we saw at the start of this month, until rate cutting paths become more certain. We say it a lot, but diversification really is key, and it’s shown its worth in recent weeks.