The UK economic system is in “significantly better form” than the grim numbers recommend, based on the fund supervisor
People walk in front of the Bank of England in the City of London financial district in London, Britain, on January 26, 2023.
Henry Nicholls | Reuters
LONDON – The UK has so far avoided a widely expected recession and business is indicating the economy may be holding up better than feared, according to veteran Schroders fund manager Andy Brough.
Figures released earlier this month showed UK GDP contracted by 0.5% in December as the economy stalled in the final quarter of 2022 to narrowly avoid a technical recession.
The Bank of England expects the UK economy to have entered a mild recession in the first quarter of 2023, but this will last for five quarters as energy prices remain high and rising market rates constrain spending.
But Brough, head of the pan-European small and mid-cap team at British wealth manager Schroders, said his interactions with companies indicated greater resilience than weak GDP numbers and official forecasts imply.
“The consumer is still spending. Every number is a surprise to the market, isn’t it? I walk up and down the streets or ride my bike to work, [and] There’s still a lot of people out there, and people are still buying houses, still buying cars, they’re still shopping,” he told CNBC’s Squawk Box Europe on Wednesday.
“There are seven wonders of the world, and the eighth wonder of the world is how GDP is calculated,” he said, adding that he was “surprised” by the magnitude of December’s contraction.
Most notably in their latest earnings reports, UK banks have increased their loan loss provisions – money set aside to protect against customers who default on their debts.
Brough advised the market not to take this as a sign that tightening financial conditions are increasing the risk of default for UK consumers, saying the companies he speaks to are actually “doing well”.
“Below x-minus corporate profitability today, we’re seeing pretty good dividend increases, pretty good earnings calls, so I think the economy is fundamentally in a lot better shape. And it’s very easy to get off on something like a Lloyds Bank and the other financial companies and say things are tough, but actually it’s a mechanical calculation, this determination.”
Lloyds Bank on Wednesday announced a £2 billion ($2.42 billion) share buyback and increased its final dividend to 1.6 pence per share. It was the latest in a string of large UK companies to report strong fourth-quarter earnings and boosted returns on investments for shareholders.
“Signs of life” in business investments
Uncertainty about future Westminster-Brussels relations has weighed on business investment since the UK voted to leave the European Union in 2016, in turn hampering productivity gains and increasing the direct cost of Brexit to UK potential growth.
Real business investment in the fourth quarter of 2022 was only marginally higher than before the Brexit vote, but recent trends look more hopeful, according to Kallum Pickering, senior economist at Berenberg.
“Although starting from a low base after the pandemic-related slump, real business investment grew by c10% in 2022 – at 4.8% [quarter-on-quarter] increase in the fourth quarter alone,” Pickering said in a research note on Tuesday.
“It remains an open question whether momentum can remain strong in the coming quarters as companies brace against headwinds from tighter financial conditions and skyrocketing energy costs, but companies have both the need and the means to continue to increase capital spending.” .”
He added that the outlook “looks favourable” if political uncertainty continues to ease – if Prime Minister Rishi Sunak’s government moves away from the populism of fallen predecessors Liz Truss and Boris Johnson, while the main opposition Labor Party declares itself under “reliable”. “Pragmatist” Keir Starmer moves to the middle – and Great Britain avoids a bad recession.
Pickering also stressed that UK businesses “lack confidence, not opportunity” as weakness in business investment cannot be attributed to concrete factors such as difficulties in funding capital spending or a lack of viable technology to support production processes.
“Non-financial corporations sit on deposits amounting to about 23% of annual GDP. Leverage of non-financial corporations is also low. At around 75% of GDP at the end of 2022, debt is at the level of the late 1990s, well below the GFC peak of 103% in 2009 and well below the current Eurozone level of 145%,” he stressed.
“With its paltry productivity performance in the post-GFC era – output per worker grew by just 5.5% between Q2 2008 and Q3 2022 – the UK is desperate for a major replenishment of its capital stock.”
In the six years of “noise and chaos” since the Brexit vote, the diminishing risk of a trade standoff with the EU should bring comfort to British businesses and financial markets, and Pickering hinted that better times are ahead.
“It is normal for politics to go wrong from time to time and for the economy to suffer. Prior to Britain’s recent wobble, this last happened in the 1970s, but when things got going again in the early 1980s, economic performance improved rapidly,” he said.
“With any luck, the worst political uncertainty that has held back corporate investment since the Brexit vote is coming to an end.”
With business investment accounting for around 10% of UK GDP, a rebound to pre-Brexit growth rates of around 5.5% could add between 5 and 6 percentage points to annual GDP growth over the next few years, Berenberg predicts.
“Is that doable? For a while yes With ongoing labor shortages and a host of global supply shortages, UK companies urgently need to increase domestic capacity to meet growing demand,” said Pickering.
“A period of quieter politics in the coming years may provide them with a suitable backdrop.”