Several factors have helped the UK economy to outperform the pessimistic pre-Brexit forecasts. The UK is a highly competitive market-driven economy that does not rely on state favour or subsidies, and has a skilled and flexible workforce. Consumer credit growth was the primary source of faster spending which boosted the UK economy. The economic tailwind of a weaker pound also enabled export order books for British manufacturers to hit their strongest growth rates for decades.
The flexibility of the UK labour market is reflected in the record number of people in work and an unemployment rate of 4.2% down from 4.7% twelve months ago. This is the lowest level of UK unemployment since 1975. There were 32.34 million people in work in February with an employment rate of 75.6% up from 74.6% last
January. This is the highest employment rate since records began in 1971. While employment is up it is only just recently that wage inflation has overtaken CPI inflation. Wage inflation grew by 2.6% year on year in March as workers enjoyed increases in pay in excess of the rate of price inflation which slipped to 2.5% in March and 2.4% in April.
The wage growth figure for January and February were the strongest for 30 months as employers had some difficulties recruiting the workers they need. A rise in salaries above prices is a boost to future consumption.
These are good figures for the UK economy which may prompt the Bank of England (BoE) to raise interest rates this year. Governor Mark Carney has said that UK interest rates are likely to rise but not necessarily as soon as many expected. Weaker retail figures in part due to the very bad weather in Q1 and a fall in inflation to 2.4% has reduced pressure on rates.
While the FTSE 100 hit a high of 7780 in January, its value then fell heavily to 6870 in late March due to concerns over UK economic prospects, global inflation sentiments, trade concerns and the rise in sterling back to the pre-Brexit levels of US$1.43. The uncertainty over Brexit is also reflected in stock market values. However, many valuation measures suggest that the UK is better value than most other developed markets. With FTSE All Share yields running at 4% we have now seen values overtake the highs of January with the FTSE 100 standing at 7821 in mid May. This recovery being supported by oil price raises, a weaker pound and the movement of capital to Britain. If investors continue to undervalue UK companies it is likely that there will be further mergers and acquisitions activity.
After eight years of austerity, UK borrowing has returned to pre-crisis levels. The government’s annual overspend in 2017/18 was £42.6bn which is £2.6bn below the previous year’s borrowing and its lowest for eleven years. Our overall debt levels stand at 86% of GDP and is expected to start falling as tax revenues increase due to the high employment numbers. Growth and revenue should make the Chancellor more able to invest in the economy and public services.
The long divorce from the EU is deterring outside investment into the UK. Analysts covering FTSE 100 companies are commenting over the unease about the level of uncertainty still surrounding the final UK/EU deal. Markets however are becoming less concerned instead believing that many of the key financial issues have already been agreed but not announced.
The agreement over a transitional period gives a sense that not that much will change for the next three years. Even with disagreement within the Cabinet over the customs union and an impasse over the Northern Ireland boarder, there are good reasons to believe that there will be a deal so that the UK and EU countries can trade in goods and services with limited friction. It remains in the EU’s interest given the trade surplus in goods with the UK is £100bn. No Eurozone government or company would wish to lose this amount of custom.
It is also in the EU’s interest to strike a deal on services as the UK financial services industry helps meet the financing needs of governments and companies across Europe. Any fragmentation of the market will likely raise the cost of capital in Europe. The need for public financial bailouts in the event of a future financial crisis may not be to the liking of many European countries so keeping the financial centre in London may benefit everyone.
The issue of the cross-border euro denominated derivatives market is perhaps the most significant of Brexit issues at this time. There are currently around £443bn of euro-denominated derivatives traded in the City of London each day. The UK-based market in euro-derivatives amounts to £26tn in contract which stretch out beyond Brexit. No European government will want a problem over an agreement to retain the regulatory and legal status of existing contracts and counterparties.
The economic fundamentals in many sectors of the UK economy are improving despite some significant headline grabbing failures such as Carillion, Carpet Right, Toys r Us and Maplin as well as predictions of slowing growth. UK employment is at record levels, wages are growing ahead of inflation, there has been a significant boost to UK manufacturing and the public finances have improved on the back of higher tax receipts. While the tailwind of low currency values has reduced the UK can expect attractive growth particularly within domestically focused businesses where valuations are attractive.