Weather puts a dampener on economic picture

Quarterly Market Overview Q3 2023 | United Kingdom

The UK economy continued to show some resilience and produce mild growth over the quarter, defying, at least for now, the gloomier predictions of an imminent recession. GDP rose by 0.2% quarter on quarter in the second quarter of the year – above forecast and higher than the previous quarter’s 0.1% growth rate. The manufacturing sector outpaced services for once, growing by 1.6% and compared with just 0.1% growth in the services sector. However, the more recent GDP figure for July illustrated the rather ‘up-and-down’ nature of the UK economy at present, as it fell by -0.5% over the month, following 0.5% growth in June. Admittedly, July’s disappointing data partially reflected the unseasonal wet weather experienced over the month, though industrial action didn’t help either. The damp mid-summer saw a higher-than-forecast month-on-month fall in retail sales in July, although they rose slightly in August. 

Inflation was another key factor exercising investors’ attention. Headline inflation continued to ease from the peak of 11.1% set in October last year and had fallen to 6.7% by August. This latest figure was a positive surprise given the market had forecast a mild reacceleration in annual inflation for the month. Food prices began to ease during the quarter but stayed at double-digit levels. Core inflation (which excludes food and energy prices) had appeared to be stuck close to May’s 31-year high of just over 7% as it rose by 6.9% in both June and July but August saw the figure decline materially to 6.2%. 

Annual growth of regular pay (excluding bonuses) in Great Britain was 7.8% in the three months to July. This was the same as the previous three-month period and according to the Office for National Statistics it was the highest annual growth rate since comparable records began in 2001. While this was positive for employees, it was less welcome news for the Bank of England (BoE) which has been concerned about wage inflation causing overall inflation to stay at high levels. As was widely anticipated, in August the BoE raised interest rates by 0.25% to a 15-year high of 5.25% and left them unchanged in September after 14 consecutive increases. BoE Governor Andrew Bailey cautioned that they could remain higher for longer to get inflation back to its 2% target. More broadly, the commentary from the Bank of England indicated a determination to ‘see the job through’. Bailey’s deputy, David Ramsden, warned that inflation remained ‘much too high’, while Bailey himself talked of the UK economy’s ‘unexpected resilience’. Although Bailey suggested interest rates were “much nearer” their peak, he didn’t rule out further rises.

Our 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, a generally improved European energy-cost outlook in 2023, or a continuing, albeit slower than hoped-for, China economic growth recovery picture so far this year. 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, including resources and financials exposure at an index level provide an important foil to our growth exposures in other asset classes and regions globally.