Episode summary
Why the UK’s Economy May Surprise Investors Again
Thoughts on the Market (Morgan Stanley)
· · 12 min · Hosts: Andrew Sheets · Guests: Bruna Skarica
Summary
The host and Bruna Skarica argue that the UK is more constructive than the market assumes, even after accounting for energy shocks, political noise, and high gilt yields. Bruna says Morgan Stanley sits in the “more constructive structural camp,” because recent capex and private-sector productivity gains suggest the UK may not have suffered the long-term collapse in potential growth that many investors fear.
The near-term backdrop is less favorable. Bruna says Morgan Stanley has cut UK growth forecasts to around 1% for 2026 and 2027 and raised peak inflation to around 3.5% later this year because of higher oil prices. Still, in the base case, the bank sees only flat activity from the second quarter, rising inflation, and no recession. A sharper move higher in oil and gas prices would materially worsen the outlook and could force the Bank of England to tighten.
On policy and markets, Bruna says the Bank of England should stay on hold in the base case, even though markets price some chance of hikes. She also argues the UK’s fiscal path is better than many investors think: medium-term plans point to a deficit below 2% of GDP by 2030, though execution risks remain. The host closes by noting that UK assets still offer meaningful risk premium, especially in government bonds.
Key takeaways
- Bruna Skarica says Morgan Stanley is in the “more constructive structural camp” on the UK, with private-sector productivity growth just under 2% by end-2025.
- Morgan Stanley cut UK growth forecasts to around 1% in 2026 and 2027 and raised peak inflation to about 3.5% because of higher oil prices.
- Bruna says the Bank of England should remain on hold in the base case, despite market pricing that leaves room for aggressive hikes if oil spikes.
- Bruna argues the UK’s fiscal trajectory is better than feared, with medium-term plans implying a deficit below 2% of GDP by 2030.
- The host says UK government bonds still offer substantial risk premium, citing a 6.6% implied 10-year yield 10 years out.
Notable quotes
“We are in the more constructive structural camp. I actually think that's probably Morgan Stanley's biggest out of consensus call on the UK”
“We have downgraded our growth forecasts to around 1% over 26 and 27 and we have lifted our inflation projections by around 150 basis points”
“if we fail to see any movement lower in oil and as you rightly pointed out, natural gas prices as well or if we even saw a move higher over the summer”
“we think the bank of England remains on hold, it's important to remember that they were about to cut rates prior to the closure of the straight of Hormuz”
“we do think that the picture is actually much better in terms of productivity growth than perhaps what the average market participants think is the case”
How the episode opens
Welcome to Thoughts on the Market. I'm Andrew Sheets, global head of fixed income research at Morgan Stanley. — And I'm Bruno Caraka, Morgan Stanley's chief UK economist.
Today, the debate around growth and debt in the United Kingdom. It's Wednesday, May 20th at 2 p.m. in London.
Bruna, I'm so glad you could join us today cuz I actually really did want to talk about what's going on here in the United Kingdom. I don't think it's an exaggeration to say that this is the country where you hear some of the strongest divergence of opinions. Pessimists point to political uncertainty, vulnerability to oil prices from the straight of hormuz and rising bond yields.
And yet UK growth this year has been pretty good. Inflation is set to come down and the currency's been pretty stable. Hardly the stuff of big instability.
So Bruno, I was hoping you could help us set the scene. Let's start with how you see the economy. I
Actually think your framing is perfect. For the past 5 years, there has been a striking divergence of opinion on the UK, which I do think mimics to a degree some of the divisions on the Bank of England's monetary policy committee. The question really is, has the country underwent structural changes in the past decade of supply side shocks such that its potential growth is very low, perhaps as low as 1% on the year?
And has the inflationary process shifted in such a way that for example we need much higher jobless rate in order to generate enough economic slack to get inflation down to 2%. Or the other question is has the UK just had a unique string of external shocks amplified perhaps by domestic policy choices which mean that we have seen a prolonged period of low growth and high inflation but again without major structural changes.
From the episode’s captions: roughly the first two minutes, lightly cleaned. Keep watching on YouTube →
Topics
- uk economy
- fixed income outlook
- energy risks
- fiscal risks
- political risks
Watch the episode
Watch “Why the UK’s Economy May Surprise Investors Again” on YouTube
Summary, takeaways and quote selection by Octagon. Quotes are short excerpts; the full conversation is in the episode.
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