The problem with the UK’s economic recovery

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The problem with the UK’s economic recovery
Pixabay/Pexels The outlook for the UK economy has improved, according to economists. (Pixabay / Pexels)

Markets have been too negative on global economic prospects but the UK could be a laggard when it comes to a recovery, economists and investors have suggested.

Steven Bell, chief economist at Columbia Threadneedle, said consumer confidence had been very low in Europe and the UK due to concerns about the impact of higher energy costs, but could rise over the year - albeit more swiftly on the continent than in the domestic UK market.

According to Bell, energy subsidies mean the issue has not had as profoundly negative an impact as originally feared. Therefore, he anticipates this will lead to higher confidence later in the year.

In fact, he said German retail sales could be very strong as investors regain sufficient confidence to spend accumulated savings from the pandemic.

The UK is a growth laggard among the major DMs.Konstantinos Venetis, TS Lombard

But Bell added that while this narrative also applies to the UK, he was less optimistic on the outlook for the domestic economy.

He said: “In the dark days of autumn, the implied probability of UK recession reached 91 per cent, an unheard of degree of agreement amongst economists.

"Not only has the energy crisis now passed, but energy prices for next winter have fallen rapidly in the last few months. We expect a fixed-price retail offer below the £2,500 cap for next winter to be available soon. That should remove a significant fear for UK consumers."

While the market is sceptical, Columbia Threadneedle believes the 2.9 per cent target for inflation at the end of this year, set by the government and now backed by the Bank of England, was entirely reasonable.

Energy bills will see a 90 per cent hike replaced with a 20 per cent cut and the impact on the inflation figures will be dramatic. But despite feeling the picture is brighter, Bell is cautious.

He said: “Before we get carried away, the big increase in mortgage rates will be a very significant drag on the UK economy.”

With this in mind, he feels the UK economy will grow, but only “modestly.”

Konstantinos Venetis, director of global macro at TS Lombard, said the UK has been “catching up” with the rest of the global developed economies since around February of this year, and feels that this is helping sterling to perform strongly against its peer currencies in recent weeks.

This is particularly the case as market participants now feel that the Bank of England will be able to put rates up to a greater extent than previously expected.

Venetis said this was “welcome” because it reduces the relative cost of imported goods, and so has the potential to dampen the impact of future higher energy prices on consumer spending. 

Money matters

More broadly, stronger sterling has a disinflationary impact on the wider economy as the price paid for imported goods falls.

But despite this optimism, Venetis said he, too, remained very cautious on the outlook for the UK.

This is because, while he feels inflation will fall sharply in the second half of this year in the UK, energy prices are set to rise markedly as the government supports end.

He feels higher energy prices, even if overall levels of prices in the economy are falling, could dent consumer sentiment in terms of spending, and also embed a higher level of inflation than is currently expected. 

Before we get carried away, the big increase in mortgage rates will be a very significant drag on the UK economy.Steven Bell, Columbia Threadneedle

Venetis said this caution, plus the tighter lending conditions in the economy will dampen inflation but also economic growth in the year ahead, with the inflation falling at a slower pace than otherwise might have been the case due to the higher energy prices. 

All of that adds up to, he said: “The UK is a growth laggard among the major DMs, with real output likely to remain below its pre-pandemic highs this year and private investment essentially missing in action.”

He said the problem with any attempt by the government’s already high debt levels, and the much higher cost of debt now.

He said Jeremy Hunt’s recent budget, which focused on reforming the supply side of the economy contained measures which are “welcome” but that are “unlikely to move the needle” in terms of the immediate growth prospects for the UK economy. 

Market movers? 

In terms of what all of this means for investors, Rupert Thompson, chief economist at Kingswood, expects a mild recession in developed market economies this year.

He asked: “Where does this all leave us?

"We believe equities face some downside risk near term due to these overly optimistic earnings expectations and valuations which are on the high side.

"Against that, equities will continue to receive support from the prospect of rate cuts down the road and have upside potential further out, particularly outside the US.”

Rupert Thompson is chief economist at Kingswood

He added: “As regards bonds, there are some potential headwinds short term from renewed upward pressure on government yields and a widening in corporate spreads. But fixed income is now offering the highest returns for over a decade and yields have scope to decline longer term."

For this reason, Thompson said he believes all of the above warrants being "broadly neutral versus benchmark in terms of equity and bond allocations".

He explained: "Within equities, our view remains that the US will underperform going forward as its high valuations will be not supported by the super-low interest rates of the past decade.

"Within bonds, we continue to move away from our very cautious positioning of the last few years, both diversifying our holdings and lengthening their average maturity.” 

Columbia Threadneedle's Bell agreed that government bonds look “attractive” as an investment right now, but outside of that he favours European and UK equities ahead of the US. 

This is because he is skeptical about the potential for US companies to hit the earnings forecasts currently expected by markets, while also being quite expensively priced.

He also said that with the US more likely to have a recession than either the UK or the Eurozone, there is a “possibility” that interest rates will rise higher in the UK and Europe than they will in the US. 

In his opinion, this would lead to relative weakness for the dollar, which dents the returns achieved by an investor in the UK who owns US equities or bonds.

So while there is a view that the UK economy could be a laggard, its equity and bond markets could be better performers, which could help improve investor confidence over the coming months.