UK Outlook

The outlook for UK assets and markets is being driven by many factors, both global and domestic in nature. The most important immediate influence is global, the developing Covid-19 coronavirus.

Initially markets saw this as a crisis focused largely on China, where the economic impact would be severe but temporary. This has since evolved to markets now reflecting nervousness and increased volatility, as they view it as somewhere between a scenario where the virus is now global but in pockets (and where the economic impact is localised and temporary) to one where it becomes more widespread. In which case the combination of the fear that the virus could spread and the battle to ensure that it does not, results in a far wider and deeper economic impact.

The worst case, where this evolves into a pandemic that takes a longer time to control and necessitating action across the globe, remains the fear. In this “fat tail risk” scenario the health risks and economic fallout would both be considerably higher.

It is hard to quantify fully the likely risks to the world economy. The economic stagnation seen in China in the first two months of this year could be seen elsewhere. The supply shock through impacted supply chains is hard to address fully through policy; instead the economic policy response is focused more on demand, through fiscal stimulus or monetary easing. Markets, meanwhile, see a flight to quality, favouring bonds and certain currencies like the yen and dollar.

An opportune time for a fiscal boost

The UK is not directly impacted. Therefore, immediate economic policy action seems unlikely in response to the virus. That being said, with the Budget only a couple of weeks away, the economy looks set to receive a major – and much needed – fiscal boost, perhaps exceeding 1% of GDP. The timing of this boost becomes all the more opportune the longer global growth is dampened by the coronavirus.

As the first Budget of a new Government one would expect a focus not only on any possible quick wins for the economy but also on a longer-term vision for the economy, as it is not possible to enact change overnight. It is already clear the focus will be on infrastructure spending, although how many projects are “shovel ready” plus the economy’s perceived ability to absorb these will be factors to consider. We will preview the Budget in more detail in a forthcoming note.

While the global backdrop has becoming more worrying, the domestic economic picture has become far more encouraging. There has been a steady stream of economic data suggesting the post-election bounce has continued.

Improving UK prospects despite downbeat economic consensus

Last year the UK’s quarterly growth rates were 0.6% in Q1, a small contraction of -0.1%, a rebound of 0.5%, followed by stagnation of 0.0% in Q4. This provided an annual growth rate of 1.4% for the year, the third highest in the G7. Since the election, however, the data points to a clear bounce.

The monthly measure of GDP showed the economy grew 0.3% in December. The Purchasing Managers’ Index (PMI) for manufacturers has risen from 47.5 in December to 51.9 in February. Manufacturing output is, however, still weak, down 2.5% over the year. The construction PMI was up from December’s 44.4 to 48.4 in January and could improve from measures in the Budget that give housing a boost.

The global impact from the coronavirus is a big unknown and could threaten to weaken the economy considerably if the virus escalated. Without this risk the economy should benefit this year from a number of features.

Consumer spending should benefit from a solid labour market, where employment growth is strong and wage growth should outstrip inflation, thus providing real income gains – and in turn giving a boost to the economy.

Recent trends, however, warrant attention. The overall increase in average earnings has edged down from 3.9% last July to 3.2% in December. Meanwhile, inflation edged up from December’s 1.3% to 1.7% in January, yet we expect inflation to remain below 2%.

However, wages could creep higher and those on low incomes, with a higher propensity to spend, should benefit from higher wages and tax cuts including higher income tax allowances. Investment, weak in recent years, should rebound, although the virus and imminent UK-EU trade talks could still impact the timing.

Overall, recent data reflects an improved domestic UK economic climate and the fiscal stimulus should help stimulate UK growth this year. While this is positive, the near-term challenge is that the global virus has created an additional uncertainty that may dominate immediate market sentiment and, if it spreads, then impact economic confidence as well.

Please remember that when investing your capital is at risk.

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