Should Investors Be Worried About the UK Economy?

With construction data looking weak, and UK GDP forecasts downgraded, should you be worried about the impact of slow growth on your portfolio?

Emma Wall 5 October, 2017 | 11:17AM
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Emma Wall: Hello, and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by State Street's Tim Graf to talk about the U.K. economy.

Hello, Tim.

Tim Graf: Good morning.

Wall: So, we've had some data this week, PMI data, which suggests that the U.K. economy is not perhaps as robust as we might like it. How should we interpret this kind of data?

Graf: I think we should interpret it as being another sluggish Q3 or another sluggish quarter, I should say, continuing on the sluggish performance of Q1 and Q2. So, it's going to make it very difficult for the growth forecast of the Bank of England to be met if this data is sustained in the hard economic data for Q3 which I think is a real challenge given they are talking about rate hikes coming up.

Wall: And are we just being too pessimistic? Because if we cast our minds back a year ago, we were very much expecting to be in recession by now. The Brexit referendum had happened; the negative nancies of this world thought that we would be with a crashing market and a recession and that's not the case. We do still have positive growth. So, should we be worried?

Graf: I think so, because a lot of that growth has come off the back of a very resilient U.K. consumer who has been able to sustain demand largely through the growth in consumer credit. Credit levels aren't worrying yet, but they might well be, particularly if interest rates are to start rising. So, I think, even though we've done a lot better than a lot of forecasts going into the Brexit vote, that is may be, I think, missing some of the broader picture which is that the U.K. economy is still somewhat fragile and very dependent on easy monetary conditions, I think.

Wall: And of course, if interest rates rise, that will hit households. That will hit them in terms of mortgages, in loans, in credit cards. What about in terms of their investments? How do rising rates and a sluggish economy impact portfolios?

Graf: I think it's going to still be very difficult. I mean, we've heard about how rate rises will be decent for savers. But we are not talking about long-term programmatic rises in interest rates. We're talking about maybe 25, 50 basis points. So, savers won't necessary be helped that much, particularly given how high inflation is. So, I think, fixed income investing in the U.K., particularly for domestic investors remains very, very challenging. Real rates, especially long-term real rates are likely to remain negative for a good period of time.

The equity markets actually might fare a little bit better because I think sterling will probably remain weak for some time. Given how much the FTSE is internationally focused that will probably be to the benefit of corporate earnings for the big large-cap U.K. companies. Small-caps may fare a little bit more difficult.

Wall: And of course, we are having this stilted economic growth because there is uncertainty in the market. Should we then expect the economic growth to remain at these kinds of levels or even dip given so much of Brexit is still uncertain?

Graf: I think these kinds of levels are probably the baseline scenario. I don't think there's going to be a disaster coming up. We have about as much political uncertainty as you can fathom right now in the U.K. economy to deal with. And the U.K. economy is dealing with it albeit in quite stagnant fashion. So, I wouldn't necessarily look for a downturn from here. But I think relative to the rest of the world we are having this pickup in growth in almost synchronised fashion around the world and it's not really happening here. So, I think it will continue to lose ground on a relative basis even if in absolute terms it probably fares OK.

Wall: Tim, thank you very much.

Graf: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.


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Emma Wall  is former Senior International Editor for Morningstar

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