‘Beast from the east’ lingers on for UK economy

UK GDP growth stalled to just 0.1 per cent in the first quarter, a notable decline from 0.4 per cent at the end of 2017 and the lowest recorded growth figure since 2012 (see Chart 1). This followed on from the economy’s 1.2 per cent growth in the previous year, the worst recorded level for half a decade.

Snow and growth were not the only things to fall in March. The FTSE 100 closed the quarter 10 per cent lower than levels seen at the start of the year. The UK’s main market has since recovered these losses to hit a record high in mid-May, but the volatility is perhaps illustrative of the uncertainty that has affected the wider economy.

Hike reversal

In light of the deteriorating data, the Bank of England (BoE) decided against a rate hike in May, a further rise having seemed odds-on just weeks earlier. The Monetary Policy Committee voted seven to two for the base rate to remain at 0.5 per cent, and suggested that weather conditions largely caused the first-quarter slump. But the BoE remains confident this signified a blip rather than a trend, with governor Mark Carney highlighting a disconnection between the underlying and headline data.

Other analysts also believe the slowdown will be short-lived. Karen Ward, chief market strategist for the UK and Europe at JPMorgan Asset Management, says: “We expect the recent weakness in the data to largely prove temporary.

“If potential [annual] growth really is just 1.5 per cent and the economy is already at full employment – as the BoE believes – then a pick-up in growth next year should precipitate a faster pace of normalisation.”

It is thought, however, the UK’s forecast GDP for 2018 will now be forced to come under revision. GDP is expected to rise to 0.4 per cent in the second quarter, but would need to grow substantially higher in order to match the Office for Budget Responsibility’s (OBR) annual forecast of 1.5 per cent. 

A rate rise is unlikely to aid the economy in this quest. Nevertheless, Ms Ward anticipates action before the year is out. “We expect the BoE to raise rates by 0.25 per cent in November, and if the global backdrop is similarly robust going in to 2019 then, much like the US Federal Reserve, the BoE could settle in to a more significant pace of normalisation next year,” she says.

Steve Davies, manager of Jupiter’s UK Growth fund, thinks the BoE could act even sooner. He says: “A rate rise in August is a perfectly feasible possibility. I thought [Mr Carney] was signalling that quite clearly. [But some] people don’t believe that Q1’s a blip.

“The BoE’s reason for looking to raise rates is that it doesn’t think there’s much slack in the economy, and therefore wages and domestic inflation are starting to perk up. The more it sees wage growth heading towards 3 per cent and the more it sees jobs continuing to be created, the more inclined it will be to find reasons to put rates up.”

As Mr Davies points out, despite the economic issues documented, the UK employment market looks healthy. The Office for National Statistics (ONS) found that in the first quarter of 2018, 32.3m people were in work, a rise of 0.4 per cent from the previous quarter and a 2.9 per cent increase from last year (see Table 1). Perhaps more tellingly, the UK employment rate of 75.6 per cent is the highest since records began in 1971.

Table 1: UK labour market statistics for January to March 2018, seasonally adjusted

Source: ONS. Copyright: Money Management

Chancellor Philip Hammond was understandably quick to revel in the figures, and data elsewhere has provided further encouragement – and a potential boost to his coffers for the Budget towards the end of the year.

The OBR had forecast the UK government would borrow £45.2bn for the 2017-18 financial year, but actual figures came in lower at £42.6bn. As with GDP, the expectation of revised figures later this year could dim some of the shine. But for now, the data is a sign of encouragement.

Ms Ward says the near-term economic and fiscal outlook could improve further if the government manages to secure a Brexit deal by the autumn. But she claims: “That doesn’t mean the government should abandon fiscal restraint, because the medium-term fiscal outlook remains dire. In the coming two decades, the working population is set to rise by a mere 8 per cent in total compared with a 30 per cent rise in the number of people over 80 who require considerable fiscal support in the form of health and social care.”

Weather or not

In the near term, the question of whether recent data is a blip or something more significant endures. Mr Davies agrees with those who say the struggles seen at some UK companies can be partly attributed to be the weather.

“Some of the retailers and anyone involved in travel quite often had multiple stores shut for multiple days,” he says. 

“It’s not just the customers that couldn’t get there, but the staff couldn’t get there to open the store. We had one of the housebuilders telling us that construction work pretty much had to stop for a week. If you lose one week out of 13 that’s a pretty substantial impact.”

The manager also questions whether GDP is the best barometer to measure the health of an economy. “Partly because it gets revised so much, and partly I don’t think it measures large chunks of the newer bits of the economy very well too,” he explains.

“I pay as much attention to employment trends, PMI surveys and the stuff that the BoE would refer to as ‘softer data’.”

But some of that softer data is also troubling. Consumer confidence remains in the doldrums, and seasonally adjusted household expenditure has fallen for 11 of the past 12 months.

Manufacturing data also suggests a recovery is far from under way. Analysts had expected the UK manufacturing purchasing managers’ index to fall 0.1 points in April from its 54.8 level in March, but instead it dipped to 53.9 – its slowest rate for 17 months.

Brexit optimism?

In the eyes of many, Brexit shoulders a great deal of responsibility for the UK’s stalling economy. Negotiations for the UK’s departure from the EU have shown no significant progress since March, according to Michael Barnier, the EU’s chief negotiator. In mid-May, he said that actual negotiations were, in effect, yet to start.

This has had an effect on the UK’s longer-term outlook. In its ‘World economic outlook’, published in April, the International Monetary Fund (IMF) predicts that Italy will be the only European country to perform worse than the UK over the next two years. It was in fact one positive piece of UK data – the unemployment rate – that the IMF flagged as a potential warning. 

The IMF said further falls, producing increased wage growth, may push up an inflation rate that is already above target due to currency depreciation.

Ms Ward, however, feels progress is being made on the main economic issue of the day. “The Brexit negotiations have reached an important milestone, with both sides agreeing to a period of transition between the UK formally leaving the EU in March 2019 and the new relationship coming into force in January 2021,” she says. 

“Both sterling and UK interest rate expectations could get a further boost if the next ambition is met: an agreement on [an outline of] terms of the final deal. There are reasons to be optimistic that a deal will be struck. But it may be some months before this emerges, and there could well be significant political and market volatility along the way.”

As a result, the situation remains uncertain. UK equity managers are having to play greater attention to macroeconomic factors than usual, according to Mr Davies. 

For those who argue that the economy will quickly overcome its current travails – and make it through Brexit negotiations relatively unscathed – there is an obvious opportunity: UK domestic stocks continue to trade at a substantial discount to peers. 

For the less certain, a watching brief remains the most likely course of action.