Declining UK growth expectations and ongoing political uncertainty
The Bank of England (BOE) left interest rates unchanged at its monetary policy meeting in February. Arguably, the more important development came in the accompanying BOE Inflation Report (IR), where 2019 UK real GDP growth was revised down to 1.2% from 1.7% on the back of slowing global trade, uncertainty from Brexit and lower than anticipated productivity gains. Even this low forecast looks optimistic; the UK economy grew just 0.7% at an annualised pace in the fourth quarter of 2018, with real business investment down for the fourth consecutive quarter, the longest uninterrupted downturn since the Global Financial Crisis in 2008. Less investment will make it more difficult for the UK economy to raise productivity and reach its long-term growth potential.
One factor that will influence the near-term UK economic outlook is the nature of the EU withdrawal. While the path for Brexit is uncertain, at least there is evidence that firms are making preparations for a potential no-deal Brexit to minimise supply-side disruptions. First, according to the latest UK purchasing manager’s index, manufacturers are stockpiling goods (and particularly in the clothing, chemical, plastics, and food and beverage sectors) at their fastest rate since records began 27 years ago. Second, the BOE’s IR disclosed that Agents of the Bank, who surveyed approximately 200 business contacts, found that around half of respondents had started implementing contingency plans for a “no deal, no transition Brexit”. And third, on the EU side, Brussels announced a package of contingency proposals in December, including measures to keep planes flying between the UK and Europe and scrapped its initial plan to limit quotas for road haulage permits to just 5% of existing UK-EU traffic to avoid trade flow bottlenecks.
Nevertheless, despite the gloomy economic outlook and Brexit uncertainty, the BOE believes spare capacity in the economy remains limited and forecasts inflation running above 2% in 2020 and 2021. As such, the BOE maintains a conditional tightening bias and expects to raise interest rates once over the next three years. For investors, the UK Gilt market looked through the BOE’s inflation projections; 10-year yields have declined to their lowest rate for over a year, while equities ignored the bleak economic outlook and rallied, as global markets recovered from oversold positions. Looking forward, the UK stock market remains vulnerable to political risks (e.g. Brexit and a potential left-wing Jeremy Corbyn government).
Political and economic risks coming from Italy
The EU’s increasingly fractious relationship with Italy is a source of uncertainty for the euro and regional markets. Politically, an extraordinary diplomatic row has deepened between Italy and France, after Italian Deputy Prime Minister Luigi Di Maio met with French leaders of the populist ‘gilet jaunes’ movement near Paris in February. Relations between France and Italy were already tense since the populist Five Star Movement (FSM) formed a government with the right- wing Lega party in June 2018. However, the unscheduled visit of Di Maio, the FSM leader, led to France recalling their ambassador from Italy, the first time that has happened since the Second World War. Di Maio seems to be drumming up populist support at home following disappointing results by his party in regional elections in Abruzzo and Sardinia.
Not to be outdone by FSM, leaders in the Lega have proposed a bill that could potentially allow Italy’s parliament to seize the central bank’s gold reserves (worth around €91bn). This has led to speculation that the government could use the gold to fund a spending program to fulfil spending promises. It does appear that Italy’s political leaders are gearing up for a snap general election, and possibly before the European parliamentary elections on the 23-26 May.
Economically, Italy slipped into recession in the second half of 2018. The country is weighed down by public debt worth over 130% of GDP, has unfavourable demographics and an ailing banking system that needs to be recapitalised. In short, European equities continue to face political and economic risks coming from Italy.
Kicking the US-China trade protectionism risk can down the road
As highlighted in the January Investment Outlook, trade protectionism is a key market tail risk. However, President Trump has since tweeted that he will delay scheduled trade tariffs (originally planned for the 1st March) on US imports from China, due to progress made in trade negotiations. Instead, Trump is likely to maintain existing tariffs and up the pressure on China to honour its commitments to purchase more US goods and make progress on resolving Washington’s concerns related to state-aid subsidies, market access, forced technology transfers and intellectual property rights. Trade protectionism remains a risk for markets, but with the 2020 US presidential elections looming in the horizon, and with President Trump keen to deliver a political “win” to his electorate, this market concern has probably eased somewhat, at least in the near term.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.