The UK economy is showing modest signs of improvement, but it is not out of the woods yet. Chris Bates provides an update on the current outlook.
The Chancellor was handed some positive news for a change when first quarter gross domestic product (GDP) came in at 0.3%, beating expectation but failing to excite equity markets. The figures show that GDP is back to the level it was at the start of 2007, but remains around 2.5% below its previous peak level. More encouraging was the 0.6% rise in services output, which accounts for around 70% of UK GDP.
Real wages continue to fall
A key issue for the economy going forward is the continued decline in real wages, which has weighed heavily on consumption. Declining real wages also remain a key piece in the UK's 'productivity puzzle', where output has fallen but employment growth has remained relatively robust. Firms continue to hire at low wages, taking on more, but not necessarily more productive, workers than they would ordinarily. Add a 15% decline in business investment from the pre-recession high and we can begin to see where the UK's growth problems lie. Unfortunately, the most striking statistic from the Chancellor's March Budget speech was the Office for Budget Responsibility's growth forecast for 2013. This has been slashed to 0.6%, half of what was forecast in December. Growth is expected to pick up to 1.8% in 2014, rising steadily to 2.8% by 2017, although these figures may prove a little too optimistic.
Monetary response?
The key question now is whether the growth figures are weak enough to spring the Monetary Policy Committee into action with further quantitative easing. While there is certainly scope, the Bank of England is not expected to restart its asset purchase programme until new governor Mark Carney takes over the reins on 1 July. What Carney has in store remains to be seen, although talk of a more flexible approach to inflation targeting suggests further monetary stimulus in some form is likely. However, a 'Kuroda-style' entrance, as we have seen in Japan, seems unlikely. We do not expect any radical change in policy until at least the release of August's Inflation Report.
Resilient equity markets
Despite the economic backdrop, UK equity markets have remained resilient. All sectors, excluding mining and oil, have delivered a positive total return for the year to date. Mid- cap stocks have led the way once more, while the FTSE 100 continues to be held back by the poorly performing mining sector. The market has been driven by the outperformance of defensive sectors, however signs that the domestic economic picture may begin to be turning a corner could favour the more cyclical sectors as we enter the summer months. Although appetite for risk has picked up, for now investors are dipping their toes in the shallower end of the risk pool. The breadth and depth of the corporate sector in the UK, combined with favourable valuations and solid dividend yields, have started to make the market appear more attractive compared to other areas of Europe, where the economic outlook remains even more uncertain.
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