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UK Economic Outlook

13 March 2019

Prospects for the UK economy have worsened since the end of 2018 with forecast GDP being revised down fairly significantly since Q4 2018. Forecast GDP growth in 2020 was revised down from 1.7% to 1.3%. However the UK is not the only economy that is expected to slow. One of the Monetary Policy Committee’s key judgements is that  global growth will be lower due to falling global trade; slowing Chinese demand; and tighter financial conditions caused by the withdrawal of financial stimulus in the US. However the expected impact of this slowing world growth is expected to have a muted impact on the UK. Whilst global growth is revised down it is still higher than anticipated growth in the UK and is therefore supportive of net trade.  

Given international factors are not expected to contribute significantly to the fall in UK GDP what is the driving force?  Uncertainty over Brexit is certainly playing a part. Business investment has been comparatively low recently in both historic terms and in comparison to investment globally. Businesses have reported that uncertainty has been the biggest headwind to increasing investment. Uncertainty may also be having a dampening effect on housing and consumer activity. Assuming that UK’s exit from the EU is not disorderly the uncertainty of Brexit is expected to wane over the coming years such that GDP growth returns to 2% in 2022 as business investment picks up and fiscal policy is loosened.

Prospects for inflation are not just due to changes in demand but also changes in supply.  Supply factors are governed by productivity and growth in available labour. Both of these factors are expected to be subdued. As immigration declines so will population growth and productivity growth both in the UK and similar developed market economies has been significantly lower in the post crisis era. This lower productivity is expected to be more persistent than previously anticipated.

All of the above is predicated on achieving an orderly Brexit, were there to be a no deal Brexit expected outcomes would change significantly.  One of the main ways uncertainty about the Brexit outcome has been transmitted up to now is via the Sterling exchange rate and this is expected to continue. The MPC has therefore looked into how GDP and inflation would change in response to changes in the exchange rate.

If Sterling depreciated by 5%  growth could be expected to increase by 0.1% to 0.3% whilst inflation would increase by 0.3% to 0.4%. Similar changes could be expected in the opposite direction were Sterling to appreciate by 5%. Two things should be noted however, firstly a 5% increase or decrease in the exchange rate is muted, expected changes should there be a disorderly Brexit, are far greater. Also this study seeks only to isolate the effect of the exchange rate.  No allowance is made for other aspects that could be impacted by a no deal Brexit. For example a second study shows that the negative impact to GDP of greater uncertainty, higher risk premia and tighter financial conditions would more than offset any boost from a depreciating exchange rate.

For pension fund investors this results in a complex picture clouded by uncertainty.  Under these conditions diversification and staying focused on strategic objectives rather than day to day volatility is probably the best policy

change in potential of 2020 UK GDP outcomes

Monthly Commentary - March 2019 - Graph 1

Source: Bank of England inflartion report.


 

[1] https://www.bankofengland.co.uk/-/media/boe/files/inflation-report/2019/february/inflation-report-february-

The author

Robert Scammell

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This document of Kempen Capital Management N.V. is for information purposes to professional investors only. The information in this document is incomplete without the verbal explanation given by an employee of Kempen Capital Management. The opinions expressed are Kempen Capital Management opinions and views as of such date only. Kempen Capital Management is registered in the United Kingdom (BR017904) at Octagon Point, 5 Cheapside, London, EC2V 6AA as a branch of Kempen Capital Management N.V. (FC032822), which is a limited liability company incorporated in the Netherlands, authorised by the Dutch Authority for the Financial Markets (AFM) and subject to limited regulation by the UK Financial Conduct Authority (FCA). Details about the extent of our regulation by the FCA are available from us on request.