This is of course extremely welcome and the press and media have jumped aboard the bandwagon, proclaiming the climb away from the Great Financial Crisis has begun and better days are ahead. A mere month after he assumed the hot-seat at the Bank of England, Governor Mark Carney is celebrated as an economic genius. Indeed, even the previously lampooned Chancellor George Osborne has been attributed a dollop of respect as the economy finally shows signs of life.
The question that we all should ask is whether this recent resurgence in the economy is a structural long term improvement or merely a short term boost to activity, fuelled by pent-up demand. The issue for us is whether this renaissance in the UK is already reflected in asset prices, given the stock market has vastly outperformed real economic growth since the market recovery began in 2009.
The Importance of a global view
The questions we receive most often from our clients refer to the UK economy. Given its importance for all of us in our daily lives, this should come as no surprise. However, we try to guard against parochialism, as the UK is such a small part of the universe for a global investor. Indeed, given that approximately two-thirds of the earnings of UK-listed companies are derived overseas, we are given an added incentive to concentrate our research upon international markets and economies. The modern day reality is that events in China and the US matter far more for our strategies than the latest conditions on the UK high street. Indeed, the primary reasons we worry at all about the UK economy is the effect that our economic performance will have upon sterling, in relation to our overseas assets, and the relative attraction of the UK gilt market juxtaposed against international markets.
Recent Spotlight on the UK
Despite our global focus, our attention has been caught lately by the data coming out of the UK. It is noticeable that economic activity within our shores has been recovering rapidly since the onset of summer. It must have something to do with the retardant summer sun, which finally reared its head in June! Should the weather be responsible is doubtful to all but sales of ice-cream and summer clothing, but it is hard to avoid the growing signs that the housing market, construction, consumer retail sales, manufacturing and business consumption are all contributing to a healthy rate of UK growth.
The UK has gone from an economic pariah to a poster-child for growth in a few months and economic think-tanks, investment banks and the Bank of England, itself, have upgraded their near term and medium term growth forecasts for the UK economy. Many have started to talk about the recuperating economy finally reaching “escape velocity” which can help propel Great Britain back to greatness and decisively away from the stagnation of 2008-12. While we are moderately positive on the UK economy for the years ahead we think such talk is premature and we continue to worry about some structural defects in the UK economy, which will impair growth in the next five years.
What next for growth in the UK?
The amelioration in UK economic conditions has been driven by weakness in sterling, pent-up domestic demand and solid (but unspectacular) global growth. Judging the impact of the aggressive quantitative easing policy of the Bank of England is perilously hard, but there seems little doubt that record low interest rates over the last few years has helped spending, primarily through keeping interest payments low and, more recently, it has aided the housing market.
The key uncertainty is whether this can continue or will these cyclical trends peter out? Starting with the outlook for interest rates, the Bank of England recently employed “forward guidance” to help investors judge when rates might next rise. Taking the Bank of England’s guidance at face value, they do not expect interest rates to start rising until at least the end of 2016, when unemployment should have fallen to 7% (according to their projections). There are secondary conditions around inflation that may lead to a change in monetary policy, but the Bank of England have effectively altered their mandate to a mixture of employment and price stability, with the former as their key factor.
Why are we sceptical?
So, if interest rates seem set to be on hold for the next three years, why are we not more positive on the longer term outlook for the UK economy? The key concerns that we have are the over-indebted state of the UK government, consumers and many UK companies, and issues in the financial sector. Despite valiant efforts to bolster their balance sheets, each part of the economy has failed to tackle the high debt levels that were accumulated in the last decade.
Low borrowing costs have allowed the economy to function, but the economic environment has not been strong enough to allow systemic deleveraging through growth. The simple truth is that interest rates will not rise as the economy is plainly not strong enough yet to withstand higher rates. Carney and his cohorts know this, so they are trying to inject confidence through their promises not to raise rates in the coming years. The Bank is also trying to force pesky savers to splurge their assets on goods and investments. Whether the low interest rate stick will be sufficient to encourage the recent revival in consumption to continue remains to be seen, but there seems little doubt that savers will be subjected to more of the same pain of the last few years.
Conclusions
We welcome the better economic news from the UK economy in the last few months and this has given us greater confidence in our forecast for a decent year for the global economy in 2014. With signs that Europe, the UK and Japan are all gaining economic traction, there is a decent chance that the world economy can belatedly return back to trend growth, after five unimpressive years.
However, we cannot yet say that the dark days are firmly behind us and structural issues still need to be addressed. The cyclical upturn might well be sufficient to help the Conservatives to a victory in the 2015 election, but we don’t think that “escape velocity” has yet been achieved. If Messrs’. Osborne and Carney can get the economic engine purring that quickly, it truly will be a “Great Escape”.
