Outlook for UK Markets

Despite the recent increased pace of economic growth being experienced by many developed and emerging countries, growth in the UK economy still appears to be hampered by significant ‘headwinds’ – from a lack of clarity in the ongoing Brexit negotiations to stubbornly high core inflation, the medium-term outlook for the UK economy and UK financial assets is becoming increasingly more difficult to predict.

Below, I’ve tried to set out the present pros and cons for the UK economy and how this may impact on UK financial assets. I have tried to incorporate global influences into my assessment, especially with regard to increasing inflationary pressures and possible higher interest rates.

UK GDP Growth and factors influencing the domestic economic outlook

The UK economy expanded more than economists predicted in the fourth quarter of 2017, with manufacturing output and growth in services industries helping to propel GDP 0.5% against a Bank of England projection of 0.4%. However, this figure translated into full year growth of only 1.8% which was the weakest since 2012 and followed a 1.9% expansion in 2016.

Although UK service industries continued to perform above trend in 2017, January’s forward-looking IHS Purchasing Managers’ Index expanded at the slowest pace in nearly one and a half years having dropped more than expected between December and January (albeit still above the level which indicates some modicum of expansion). The January report also indicated less activity in the services sector and lingering concerns amongst participants surrounding the UK’s proposed exit from the EU.

The slowing UK economy was also highlighted in poor UK retail sales figures for December, when sales volume dropped by a more than expected 1.5% from November – which was the biggest fall since June 2016 and the largest in seven years for the month of December. This was then compounded in January when retail sales rose only 0.1% from December – far short of any economist prediction (for a median 0.5% rise) and the slowest January gain since 2014. It was not surprising then that a Markit survey on behalf of Visa also confirmed that January’s fall in total UK household spending was the first such drop since January 2013 and highlighted rising living costs with commensurate lacklustre wage growth.

Given the negative tone of the above statistics, it was somewhat surprising that the National Institute of Economic and Social Research (NIESR) raised its annual growth forecast for the UK economy in 2018 to 1.9% from a previous 1.7%. The report cited a more positive global growth outlook as well as progress in the Brexit negotiations as the main contributors to the upward revision.

From an inflation perspective, core UK inflation accelerated to 2.7% in January from 2.5% in December (economists had only expected an increase to 2.6%). However, output price inflation slowed by a more than expected 2.8% in January from 3.3% in December. Bank of England reaction was fairly muted and chief economist, Andrew Haldane, confirmed that the Bank was in: ‘no rush to hike rates again’ following November’s 0.25% increase. Market reaction to the inflation numbers remains more elevated and some economists are pricing in a possible rise in UK interest rates as early as May.

External / international factors affecting the UK economy 

The main international influence on the UK economy is the Sterling exchange rate, especially against the US dollar (in terms of the pricing of oil and other commodities) and the Euro (as the currency of our principal trading partner – the EU).

The recent weakness of the US Dollar has, on balance, probably helped the UK economy given our negative and widening balance of trade with the rest of the world and our dependence on oil imports. However, an ongoing appreciation of sterling has also begun to hamper UK exporters and especially those multinational companies who report a high proportion of their revenues in US dollars.

In terms of our trading relationship with the EU, this is now firmly predicated on the eventual outcome of the Brexit negotiations. A positive outcome for the UK is uncertain as the vexed questions of post-Brexit tariffs and a customs union agreement remains as elusive as the free movement of goods / borders between Northern Ireland and the Republic or, definitively, between the whole of the UK and the ROI. Add to this mix the questions of free movement of EU citizens and non-EU immigration and a positive Brexit agreement seems light years away.

The recent uptick in global growth could be positive for the UK but Bank of England Governor, Mark Carney, recently warned that, whilst the global economy is accelerating, the UK would only benefit when greater clarity about Brexit emerges. He added that, in his opinion, Brexit: ‘has already cost the UK economy billions of pounds in lost output. Also, investment in other of the advanced economies is now growing at double digit rates whilst it’s only in low single digits here in the UK’.

The outlook for UK inflation, interest rates and financial markets   

As mentioned above, core UK inflation continued to rise in 2018. However, the Bank of England does expect inflationary pressures to moderate as we move through the rest of this year. Wage growth is only likely to increase by enough to eliminate the present gap between incomes and household expenditure and is therefore expected to be inflationary neutral.

UK house price inflation remains fairly static as a lack of properties for sale counterbalances any shortage in scarcity of finance options for prospective buyers.

However, the interest rate outlook could all change if increased manufacturing pricing power returns as a result of higher global growth. Indeed, we’ve already seen US bond yields jump to their highest level since 2013 with possible further increases likely as and when the Fed raises its short-term funds rates. For the UK, the Bank of England will no doubt have the unenviable task of managing a slowing economy against the threat of higher international interest rates from robust global growth.

As regards UK financial markets, the outlook (as usual) continues to be driven by international sentiment emanating mainly from Wall Street. Bonds are already beginning to adjust to the possibility of higher interest rates as global growth picks up and QE in the US and, to a lesser degree, in Europe looks to unwind. This scenario will almost certainly  impact on Gilts and Sterling Corporate bonds with yields trending higher and prices moving lower as a result. In such conditions, ideally we would be underweight bonds with a view to establishing a neutral position once optimum yields are reflected in underlying bond prices.

Higher interest rates are, of course, unwelcome to most asset classes but can be mitigated in the case of equities as higher economic growth often leads to improved corporate earnings in the medium-term. As UK equities (particularly the FTSE100) have been underperforming stocks in the US, Europe and the more developed Asian markets, there may be a medium-term buying opportunity in UK large cap multinationals if higher global growth rates persist and the Dollar strengthens as a result of an improving US domestic economy.

To summarise, UK financial assets vulnerable in respect of a satisfactory outcome for Brexit and the present level of core inflation moderating as predicted by the Bank of England. Whilst an agreement on Brexit could see UK stocks rally and valuations currently reflect the political uncertainty, the risk remains to the downside as Brexit weighs on market sentiment.

Please note, this article is for information only and does not constitute investment or tax advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise; pension rules and tax legislation are subject to change. If you would like investment or pension advice on your individual circumstances, please do not hesitate to get in touch on 01392 875500 or info@SeabrookClark.co.uk

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