Key Takeaways
The UK economy has entered a technical recession, but we think the recent GDP numbers will mark a low point and expect an upturn from here.
UK unemployment is low and employment is growing. Consumer confidence is in good shape – energy prices are lower and mortgage rates have eased.
Recent inflation numbers bettered expectations, but we don’t expect the Bank of England to cut rates soon.
The Federal Reserve and European Central Bank will also move cautiously but we expect them to cut before the BoE.
Better growth, stronger currency and lower interest rates are good news and we are positive on the outlook for equities. We still don’t anticipate outperformance from the UK, however.
Last week’s news that the UK had moved into ‘technical recession’ with the release of a contraction in Q4 GDP hit the headlines well beyond the financial press.
We think the numbers mark the low point in the UK outlook and expect a significant upturn from here. We examine the implications for UK markets, if our judgement is correct.
First, note that the term ‘technical recession’ merely refers to two consecutive quarters of negative growth. The UK does not have a proper system for determining recession, unlike the US, where a committee of economists opine on the matter. If we did, I doubt that they would call a recession in the UK at present: unemployment is low and employment is growing. Yes, UK growth has been sluggish but it’s not a recession in my view.
More important are the immediate prospects, which is for a significant pick up in growth here in the UK. Weak consumer spending, a major factor behind the sluggish growth in 2023, is set to recover in 2024. Real incomes are on the up, bolstered by falling energy prices and lower taxes. Consumer confidence has already picked up markedly. Mortgage rates have fallen significantly from their highs last summer and there are clear signs of a recovery in the housing market. Rightmove house prices rose strongly month on month in both January and February. The dark days of 2022 and early 2023 when household energy bills and inflation were soaring are a thing of the past. The wage price spiral is going into reverse and despite all the gloomy talk in the media, household balance sheets are actually in good shape and consumers have the income to spend.
We also had some very good news on UK inflation last week, with a significant decline in the numbers across the board confounding pessimistic expectations.
Despite this, don’t expect the Bank of England (BoE) to start cutting rates soon. Yes, price inflation is falling fast but it remains well above target and wage inflation is still far too high. The 9.8% rise in the minimum wage due to take effect in April will add to the BoE’s concern.
The forecasters at the BoE have had a tough time of it, failing to anticipate either the rise or the fall in inflation, while their projections on the real economy have been will wide of the mark. So the BoE committee will be reluctant to base any judgments on a forecast. With unemployment still low, they don’t have to.
Markets are pricing in almost 1% of cuts in Bank Rate over the next year. That is admittedly significantly less than they were expecting a month ago but it’s still substantial. We think rates will fall that far and go down further eventually but expect the BoE to be very cautious before making the first cut. Central banks in the US and Europe are likely to be cautious too but I reckon they will move first. If that’s the case and we see stronger growth, lower inflation and rates remaining high in the UK, sterling should benefit against both the US dollar and the Euro.
Let’s be clear, I’m not forecasting a boom in the UK but growth looks set to improve in both absolute terms and relative to the US and Europe.
So if the UK economy improves, can we expect a pick up in the UK stock market? Not necessarily. The FTSE 100 is dominated by global companies who earn their profits overseas. Stronger sterling would do them no favours. Smaller companies should fare better as they tend to be more domestically orientated but the biggest sector in the FTSE 250 index of companies outside the FTSE 100 consists of UK funds, who invest all over the world.
Better growth, a stronger currency and eventually lower interest rates are all good news and we are positive about the outlook for equities, we just don’t think the UK market will outperform.
