UK Economic Outlook: Going viral
Firstly, lets deal with the elephant in the room, or rather, at the other end of the mass spectrum, the virus in the vial. Rather, like the victims of the new coronavirus, markets have been feeling alternately hot and cold. Initially, with the news about the spread of the virus to areas outside the epicentre, equity markets particularly those in Asia fell. However as rumours of vaccines, low mortality rates and potential containment spread equity markets rebounded. Not everything is virus related and the competition of the first phase of the US /China trade deal provided a boost to markets. Whether there is a boosting second phase remains to be seen, indeed the workability of the first phase is viewed with scepticism by some. The number of experts in epidemiology seems to be multiplying as quickly as the number of cases of the new coronavirus, and, whilst I am not about to add myself to that list; I can offer an opinion on the economic impact.
Being around the time of their New Year celebrations, the outbreak could not have happened at a worse time for China; people should be travelling and celebrating i.e. spending money, not locked down in ghost towns. If this spending is now cancelled rather than deferred then this will have an impact on the Chinese economy with a number of commentators suggesting Q1 Chinese GDP will now be significantly lower. Contagion to other economies is likely to be more limited, but tourism will be impacted in destinations popular in China; notably Hong Kong, Thailand and Cambodia. Outside of Asia the impact is likely to be limited. This is all assuming that the spread is contained; if China continues to shut down cities global supply chains may start to be impacted and commodity dependent countries, such as Saudi Arabia, may also begin to hurt. At the moment it is simply too early to conclude what the final impact will be, unless you were an expert in virology...
Closer to home the Bank of England voted not to cut its policy rate. This was expected to be a close decision, with markets assigning a 50% probability to a cut early in January. However, in the end it wasn’t close, with a 7-2 vote in favour of maintaining rates at 0.75%. The reason such a high probability had been attached to a cut was that data released in early January had been dreadful. The composite PMI numbers released was below 50 – this points to an economy in contraction. This was backed up by the monthly GDP figures showing that output had fallen by 0.3% in November. Inflation data also came in lower than expected giving the MPC a further reason to cut rates. However, in the face of all this data, the second half of the month was improved; labour market and wage data remained strong and a preliminary estimates of the composite PMI were well above 50 showing an expanding economy. This may be the start of a Boris bounce but could just be noise.
The MPC seems to think the latter; released at the same time as the MPC decision was the Bank’s latest assessment of the UK economy. Whilst their inflation projection were little changed from the previous assessment in February, growth expectations were revised down significantly by 0.3% every year between 2020 and 2022. The MPC also noted that the economies potential had also reduced, meaning that the UK can now not grow as much as before, without generating inflation. With this in mind why did the MPC not cut rates. I suspect the main reason is that the Bank will only want to move if and when the economy enters recession. With much Brexit uncertainty still ahead that cannot be ruled out and some dry powder then will be very useful.
What does all this mean for pension schemes? Firstly expect some volatility, whilst markets are currently optimistic about virus contagion it remains an evolving situation so could change rapidly with emerging market equities likely to be worst hit. Whilst investors in emerging market expect and, indeed get paid for experiencing volatility, moves can be dramatic; for example Chinese shares are currently 10% below their mid-January levels. As always remember that as long-term investors, day-to-day volatility should not be a source of intense concern. Secondly do not expect UK interest rates to increase any time soon. With growth being revised down, inflation low and Brexit uncertainty still high, there is still plenty of opportunity for long dated yields to fall.