UK economic growth outlook gets modest lift from IMF

Stubbornly high inflation and rising interest rates preoccupied investors during the period. Economic growth was, on the whole, uninspiring. Month-on-month Gross Domestic Product (GDP) in March unexpectedly fell by -0.3%. The services sector accounted for much of the sluggish performance as the teachers’ strike, in particular, had a negative impact on the economy. A rebound in the services sector in April supported monthly GDP growth of 0.2%. In the first three months of 2023, GDP rose 0.1% – the same rate as the final quarter of 2022 and in line with forecasts.

On the inflation front, the news was not good. Annual inflation of 10.1% in March was higher than forecast and only slightly below February’s 10.4% level. Rising food prices drove the higher rate, despite a fall in petrol and diesel prices. A lower-than-expected fall to 8.7% in April disappointed investors and increased prospects that the Bank of England (BoE) would need to keep raising interest rates. An unchanged inflation reading of 8.7% in May confirmed the inevitable and the BoE continued its policy of using interest rates to tame inflation. A significant challenge to policy makers, annual core consumer price inflation (excluding energy and food prices) rose in May to 7.1%, above market expectations, and marking the highest level since March 1992.

After raising interest rates in May by 0.25% to 4.5%, the BoE surprised markets with a 0.5% hike in June to 5.0%. This was the thirteenth consecutive rise and took interest rates to their highest point since 2008. The BoE said the decision was needed to deal with persistent inflation. Despite the pressure it put on borrowers, BoE Governor Andrew Bailey was blunt in his assessment of the situation: “if we don’t raise rates now, it could be worse later”.

Wage-driven inflation remained another concern for the BoE. Average weekly earnings (including bonuses) increased by 6.1% year on year in the three months to March and by 6.5% in the three months to April. With inflation fuelling the cost-of-living crisis, pressure to raise wages intensified. The unemployment rate in the first three months of 2023 rose 0.1% to 3.9%, although the reading of 3.8% in the three months to April was lower than forecast.

Despite these economic headwinds, the UK economic growth outlook received a small vote of confidence from the International Monetary Fund (IMF) in May. The IMF upgraded its forecast for UK real (constant prices) GDP growth for calendar 2023 to positive 0.4% year on year, and up sharply from its previous negative growth estimate of -0.3%. Explaining the relative improvement in economic fortunes, the IMF noted that “buoyed by resilient demand in the context of declining energy prices, the UK economy is expected to avoid a recession and maintain positive growth in 2023”.

Looking further ahead, the IMF continues to expect annual GDP growth of 1.0% in 2024.

The period ended with signs that consumer confidence might be returning. Warmer weather helped retail sales increase unexpectedly in May, rising 0.3% month-on-month, and the second monthly rise in a row.

In currency markets, sterling appreciated mildly versus the US dollar. After strengthening in April, sterling weakened in May. However, expectations of further UK interest rate rises and the Fed taking a less aggressive approach saw sterling strengthen further in June.

Brooks Macdonald’s view

We have a positive outlook for UK equities. This might appear to run counter to the present challenge of muted economic growth versus stubborn inflation, but the domestic picture is not the only driver for the UK equity market investment case. The UK economy and equity market are not the same. UK equities in aggregate have a large international skew, with around three quarters of their revenues at an equity index level derived from outside the UK. As such, the UK stock market is particularly sensitive to global trends, be they exposure to a still-resilient US consumer-led economy, an improved European energy-cost outlook, or a continuing China-economic re-opening. The continued relative valuation attraction of UK equities makes up an important component of our barbell strategy (describing balance between different equity investment styles). The UK value exposures that we seek provide a valuable foil to our growth exposures in other asset classes and regions globally.