How is the UK Economy Faring?

The UK economic outlook is decidedly less rosy than it was just four months ago with reports of an £18 billion 'black hole'. Ahead of today's Budget, we investigate

Andy Brunner 16 March, 2016 | 8:11AM
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Healthy household and government spending growth means the UK economy is expected to have grown 0.5% in the last three months of 2015, but there was a decline in investment, possibly due to EU referendum concerns.

The latest data continues to be mixed with strong retail sales in January, up 2.3% on the previous month, and solid consumer fundamentals. But investors should remember retail sales correlate poorly with GDP consumption data. Mortgage approvals are also rising but industrial production disappointed in December.

Purchasing Managers' Index is often an accurate indicator of economic health across the private sector, tracking variables such as output, new orders, employment and prices across key sectors. The latest figures revealed worryingly weaker business conditions – the manufacturing sector was 50.8, down from 52.9, and services 52.7, down from 55.6.

Taking into account these mixed signals, GDP forecasts for the first three months of this year are being lowered, and the total growth expected in 2016 is now 2%. Interest rate rise forecasts are also being pushed back into the first quarter of 2017. The Bank of England’s Monetary Policy Committee is decidedly more dovish and the financial futures market is currently pricing in the chances of rates being higher at next December’s meeting at just 0.5%, staying the same is a 66% probability and a cut 34%. Most expect no rate rise until the first quarter of 2017. Indeed, there are suggestions that one MPC member will vote for a cut at the March meeting tomorrow.

The key issues and uncertainties are Brexit and downside risks to the global economy. The consensus view is that the former will prove damaging to the UK economy but forecasts of the extent vary considerably. Citi Bank expects GDP growth 1% or so lower at 1% through 2020 and inflation up to 2% higher at 3.5% by 2018.

Sterling is currently oversold on Brexit fears following a 10% decline for the trade weighted index since mid-November, especially as money flows to the bookmakers show the odds unchanged over that period, broadly 1/3 on in favour of remaining in the EU. Sideways trending for now appears likely, but with potentially a sizeable recovery in prospect should the bookies be proven right.

Fixed Income

Although risk assets began rebounding on February 11, it is only in recent days that US and UK government bond yields have moved decisively above the lows and they remain below early February levels. Worth remembering that at the peak of the turmoil in mid-February US 10-year yields were at 1.53% and similarly dated UK gilts yielded 1.27% compared to 1.87% and 1.48% respectively at the beginning of March.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Andy Brunner

Andy Brunner  is Head of Investment Strategy, Morningstar UK

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