What's Driving the UK's Surprising Growth?

A resilient labour market and rising house prices are helping drive UK consumption but are doing little to correct long-term imbalances, says Morningstar's Jose Garcia Zarate

Holly Cook 18 July, 2014 | 12:00AM
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Holly Cook: Hello and welcome to Morningstar. It’s time for us to check in on the health of the UK economy and joining me to do that is Jose Garcia Zarate, he’s a senior analyst and economist with us here at Morningstar. And we’ll be talking to him on a quarterly basis to check how the economy’s doing.

Jose, thanks for joining me.

Jose Garcia Zarate: You’re welcome.

Cook: So, lots of positive news coming out of the UK economy recently. In fact, UK GDP is growing at an annual rate of 3% and that’s a fair clip – what’s fuelling that?

Garcia Zarate: It’s actually quite surprising, the news that we’ve been having from the UK economy. GDP is growing at an average rate of 0.8% on a quarter-on-quarter basis, and that compares very, very positively to neighbouring counties, in the Eurozone for example.

Where most of the growth is coming from is mostly from domestic demand. I mean a combination of private consumption, because the labour market has been surprisingly resilient throughout the crisis actually. And also a bit of monetary illusion backed up by rising house prices and that’s actually offsetting the fact that wages are not keeping up with inflation. But people feel overall a bit better because house prices are going up.

Cook: Now of the house prices aren’t good news for everyone, but other than that are there any points underlying this annual growth number that are cause for concern?

Garcia Zarate: Not so much cause for immediate concern, but perhaps medium-term, long-term concern. We’re both UK residents and I’m pretty sure you recall the calls for a rebalancing of the UK economy, moving away from private consumption…

Cook: Yes

Garcia Zarate: …and housing market dependency, towards exports and investment. Becoming a bit like Germany, basically. And that hasn’t happened. It doesn’t mean that investment is not growing, because obviously domestic demand is actually improving, but the idea that the UK has actually become a net exporter of goods and services, well that basically hasn’t happened at all. The rebalancing hasn’t happened. That may have implications further down the line.

Cook: So in the future, at some point, something’s going to have to change and presumably it’s going to be the next generation that feels the sting of that.

Garcia Zarate: Well, the thing is that if you want to create a new growth pattern, then basically you need to do a lot of structural reform and not just think that because you’ve got cheap sterling relative to other currencies, that everything is suddenly going to transform into a new, wonderful, goldilocks scenario. That doesn’t happen anymore in a globalised world.

Cook: I think your research has also unearthed some interesting ideas around public debt. Can you explain what the issue is there?

Garcia Zarate: Well it’s just that I think it’s highly ironic that the global economic crisis – I’m not sure we can actually talk about crisis anymore, but anyway – the origin was an excess of debt. And obviously both here in the UK and also in other countries the stock of public debt has actually grown quite significantly. I mean, in the UK, for obvious reasons we had to rescue the banks and that implied a significant increase almost overnight on the public debt stock. Right now, I don’t think that’s actually featuring strongly on investors’ radar but longer term I think the future generations will have to deal with it.

Cook: One thing that is featuring very heavily on investors’ radars is interest rates. We hear almost on a daily basis people guessing when they’re going to rise. When they do rise, what impact is that going to have on the UK stock market?

Garcia Zarate: Well I think the messages coming from the Bank of England sometimes have been a bit muddy and haphazard, I think mostly because they themselves have been surprised by the speed of the recovery, but they all point to a process of normalisation of UK monetary policy. That basically means that interest rates are going to go up sooner rather than later. Does that mean they’re going to increase very fast? I don’t think so. The Bank of England itself actually says that any increase in interest rates will be fairly gradual and possibly towards a new normal of 2.4%-3.0%. I think that’s fully priced into the financial markets, so I wouldn’t think it would be a surprise.

Cook: So for equity investors, we shouldn’t be expecting a shock reaction because it’s not shock news, but for those people who’ve been engaged in this housing market boom and have mortgages, no matter how fast that interest rate rise happens it’s going to have quite a severe impact on them on a monthly basis.

Garcia Zarate: Well of course the mortgage rate is not the same as the Bank of England rate, it’s substantially higher, so any increase even though it’s going to be gradual and perhaps it’s not going to be massive, will have an impact on disposable income and mortgage payments will go up. And that’s something that households will have to really start thinking about and budgeting for.

Cook: Well I think in three months’ time we’ve got a lot of things to talk to you about, and in particular we’ll look at this rebalancing and whether there’s been any move towards this export and investment-led growth that we’ve all been promised.

Garcia Zarate: Ok.

Cook: Thanks very much, Jose.

Garcia Zarate: You’re welcome.

Cook: For Morningstar, I’m Holly Cook. Thanks for watching.

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Holly Cook

Holly Cook  is Manager, Morningstar EMEA Websites

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