As the UK's role as a leading actor on the global stage hangs in the balance, head of Alternative Investments, Simon Burgess shares his insight and commentary on the state of the UK's economy and the global backdrop.
As the tight rope walk progresses one step at a time, with the occasional step back, the audience is poised; some anticipating a fall with others willing the country on to a finale and rapturous applause.
While the constitutional chaos (as political journalist, Robert Peston described it) plays out centre stage, the British economy balances on a ball at the edge of the circus ring.
So, is the UK heading for a recession or was it just August talking? Defined as two consecutive quarters of the economy shrinking, a UK recession is, to some people, now looking more likely, but to others it will probably be avoided this year. It is a fact that markets are typically down in August, as has been proved every year for the past decade.
The relevant measure of a technical recession is the value of goods and services produced in the UK: its gross domestic product (GDP). From figures published on 9 August, by the Office of National Statistics (ONS) UK GDP contracted by 0.2% on the previous quarter. This is the first drop since the fourth quarter of 2012 (also 0.2%) and is equal to the biggest drop since the 2008 credit crisis. GDP was flat in June 2019, recording no growth.
While the overall growth picture in the UK might seem negative, there were some positives, most notably in the British services industry. The information and communication sub-sector was a particularly positive driver (growing by 1.6%) but this was offset by the architectural and engineering sub-sector showing a notable fall.
In aggregate, the services sector grew by 0.1% in the quarter in contrast to production output being down (by a fall of 1.4%) and construction also down (showing a fall of 1.3%). It is clear that UK companies continue to hold off investing.
Corporate profits are also reported to be the worst for three years, with the London Stock Exchange recording over half of the FTSE350 showing lower profits and more than 30% with lower sales in the second quarter. That said, profits from larger companies (especially the top 40) are reporting a healthy increase of 13%, with consecutive growth for more than two years.
Otherwise, UK government spending and household spending added to output in the quarter. This may boost confidence.
Confidence may also be injected in anticipation of the UK government propping up the economy with an introduction of a Keynesian policy where public spending is increased markedly. This could boost the economy as a whole, just when it's needed. UK Prime Minister Johnson has already pledged substantial investment for hospitals and the National Health Service, schools, security, the development of run-down towns on top of fast rail lines and the anticipated roll-out of 5G mobile network. This, of course may be subject to him holding on to his premiership.
According to the UK Infrastructure & Projects Authority, as at November 2018 there were £600 billion of infrastructure projects in the pipeline. One of the most high profile is HS2, the high speed rail line, although the first phase of this project has now been delayed by up to five years as well as the cost spiralling from £62 billion to over £80 billion.
Isn't now just the right time to invest?
Certainly, with 10-year UK bonds so low, below 0.5%, there is every incentive to borrow to fund UK infrastructure and in turn boost UK growth. The economist John Maynard Keynes advocated for increased government expenditure and lower taxes to stimulate demand to pull the economy up by its bootstraps. But others argue against this, seeing it as potentially inflationary and not in the long term interests of the country.
This second quarter contraction contrasts with the 0.5% growth in the first quarter of 2019. That was marked by a spike in businesses building up their inventories in both the UK and Europe ahead of the, then, planned Brexit on 29 March. But when that didn't happen companies stopped buying, and used their stockpiles instead.
It can be reasonably assumed that, as the country counts down again to a possible Brexit, hard or otherwise, on 31 October (if that date doesn't change again), British business will repeat stockpiling during the third quarter of 2019. If businesses do build up their inventories again, this may give another boost with positive GDP growth averting a technical recession. We'll have to see...
Of course, it is worth remembering that, notwithstanding the current statistics, UK GDP remains 1.2% higher than last year, so it's not all doom and gloom!
UK's balance of trade (its relationship between the value of imports and exports) shows high levels of volatility. In the last quarter, both importing and exporting of goods and services dropped markedly, by £16 billion to £4.3 billion The value of goods and services exported dropped £3.6 billion to £160.6 billion and the value of imports dropped a whopping £19.6 billion to £164.8 billion. Of this latter drop, £18 billion consisted of goods alone (a 13% fall). A hard Brexit could certainly add to this volatility, especially in the immediate future as Britain gets used to a new operating dynamic and tariffs.
Whichever way you paint it, we are living in uncertain times. The UK is currently faced with an increased set of risks, including: Britain leaving Europe without a deal from 1 November; potentially under World Trade Organisation tariff rules; the possibility of a general election falling on or near the same date; and then the inevitable and immediate need for a new budget; not to mention the risk of an extreme left wing UK government; and the potential for further falls in the pound.
Whatever happens, there is high likelihood of the Bank of England cutting interest rates by early 2020. Though, the challenge is that they've hardly got anything to play with without moving to negative interest. We could be faced with the prospect of effective money printing via a round of quantitative easing.
Any combination of these factors could be inflationary for the UK, which, as Mark Carney, the Governor of the Bank of England suggests, will probably be allowed by the British central bank in order to mitigate risks of British job losses. Perhaps the greater of two evils.
For now, unemployment in the UK is under control. But has it peaked? The ONS issued their August report stating that the UK employment rate is at 76.1%. 2019 is a record high since records began in 1971. Investors exposed to the UK assets should closely monitor how well the country maintains this.
In part two, I will explore the global economic context and how the UK fits into the wider picture.
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