Future of the UK economy
Brexit, Budget and beyond: what's in store for UK investors?
Uncertainty is dogging the UK economy as Brexit looms large.
The prospect of leaving the European Union (EU) in less than two years is now one of the biggest worries for advisers' clients.
In his Autumn Budget, chancellor Philip Hammond warned of slowing GDP growth in the UK, while at the same time revealing £700m had already been invested in the Brexit negotiations, with another £3bn set aside for the next two years.
Guy Stephens, technical investment director for Rowan Dartington, admits: "Whatever your political persuasion, this is not good for economic and consumer confidence."
It is not just economic growth that has stalled but other UK statistics are causing some concerns among economists, advisers and investors.
Low productivity growth and wage growth, creeping inflation and potentially rising interest rates are potential headwinds.
Azad Zangana, senior European economist at Schroders, warns: "Not only could higher Brexit uncertainty cause inflation to rise, but also confidence to fall, reducing business investment, and moving some jobs overseas."
But investors in UK equities would be forgiven for thinking Brexit has in fact been a boost for stockmarkets.
The FTSE 100 index has been steadily climbing for the past 12 months, as a weakened sterling helps overseas revenues.
So what is in store for the UK economy as the government treads a path towards departing the EU?
This report will look at the prospects for UK investors leading up to and beyond Brexit.
Ellie Duncan is deputy content plus editor at FTAdviser
Brexit is by far the biggest client fear
Brexit uncertainty and the future of the UK's economy when we leave the European Union is the biggest fear preying on clients' minds, advisers have said.
A snapshot poll carried out by FTAdviser among readers this month revealed Brexit was the biggest worry for clients, according to 64 per cent of the advisers responding to the question 'What is the biggest concern for your clients at the moment?'.
Global politics, even including rising tensions between North Korea and the US, only chalked up 17 per cent of the vote, while inflation - at 6 per cent - and interest rate rises - at 13 per cent - seemed to be barely bothering clients, according to the FTAdviser Talking Point poll.
With the uncertainty around what Brexit will entail, and how this might affect the UK economy, the overall financial stability of the country appears to be in the hands of politicians, which worries some investment advisers.
Guy Stephens, technical investment director for Rowan Dartington, says: "Whatever your political persuasion, this is not good for economic and consumer confidence.
"The recent interest rate rise and the preceding guidance from the Bank of England have stopped speculators shorting sterling and provided some stability.
"That said, if the Brexit negotiations do take a decisive turn towards a ‘no deal’ scenario, which is now being seriously considered in Brussels and on Wall Street, then we would probably see a leadership challenge.
"Weak leaders are always bad for economic growth, especially when the alternative is so polarised in political views."
Mr Stephens adds: "Businesses cannot invest on a three-year view if they don’t have the stability of economic and tax policy.
"The UK’s productivity growth is already demonstrably inferior to that of other G7 countries and without clarity soon, this will remain dormant and fall further behind."
FTAdviser has previously reported that Conservative MP John Redwood, a prominent advocate of the UK leaving the European Union and chief strategist for investment firm Charles Stanley, had been urging investors to reduce their exposure to UK assets as a result of Brexit fears.
However, there are many other concerns on the horizon that the lay investor might not know about, but which are more pressing on the financial services industry.
According to the Tax Incentivised Savings Association's (Tisa's) annual report, Brexit concerns are outgunned by the incoming Mifid II regime, which will be law from 3 January onwards, despite being a European Union regulation.
In the report, Jeffrey Mushens, technical policy director for Tisa, wrote: "Regardless of Brexit, Mifid II continues to apply to UK financial services and will be incorporated into UK regulation in January 2018.
"This is a significant piece of regulation which will have a major impact on the financial services industry, requiring a great deal of preparation over a tight timescale."
The high level of concern over what Brexit might mean has barely abated over the past year.
In November 2016 FTAdviser conducted a similar poll, which found 57 per cent of advisers were concerned about a 'Hard Brexit' more than other issues, such as a slowdown in China or the effect of a new Republican President in the US White House.
At the time, some commentators expressed positivity about opportunities for Britain when it came to the Brexit negotiations.
Rishi Sunak, MP for Richmond (Yorks), said: "Upon leaving the European Union, Britain will find itself with more opportunities for economic innovation than at any time in almost 50 years.
"As the date of our departure draws closer, it will be the responsibility of government to ensure Britain is not timid in seizing those opportunities."
However, the Federation of Small Businesses has recently called on the government to give small firms a "firm commitment to a transition post-Brexit" amid reports of protracted and difficult Brexit negotiations with European politicians.
Simoney Kyriakou is content plus editor at FTAdviser
UK investors have had a pleasant ride over the past decade as the FTSE 100 has risen solidly. But what potential headwinds lie in wait for the UK?
Brexit uncertainty, Budget expectations and let-downs and the Bank of England’s monetary policy decisions have combined to create much uncertainty.
On the one hand, equities are still doing well. The FTSE 100 has risen from strength to strength – it is trading above 7,000, up from 6,678.74 a year ago – and unemployment is low.
Alongside low unemployment, however, is low wage growth and rising inflation; the average growth in inflation over the past 12 months is 2.8 per cent, compared with the average weekly earnings wage growth of 2.2 per cent over the same period, according to the Office for National Statistics (ONS).
Although we have seen a rise in the FTSE 100 we have also been informed of a predicted slowdown in the overall economy. Currently, according to the quarter three statistics from the ONS, UK GDP grew by just 0.4 per cent over the third quarter.
Predictions for 2018 do not look too peachy, either. The Organisation for Economic Commerce and Development (OECD) has put UK GDP growth at 1.02 in 2018 while in the Budget in November, the Office for Budget Responsibility (OBR) revised its medium-term predictions downwards, citing real GDP growth of 1.4 per cent for 2018.
These estimates are far less than 2.38 per cent growth rate predicted for the US and 2.04 predicted for Germany in 2018, according to the OECD.
Moreover, after the Budget, 10-year gilt yields fell approximately 2 basis points in response to a more gloomy prognosis for UK growth.
Add to this the fact inflation has for several months in a row persisted in remaining above the Bank of England’s (BoE’s) 2 per cent target, while interest rates are projected to rise over 2018, and there could be clouds on the horizon.
Azad Zangana, senior European economist at Schroders, says: “Interest rates are unlikely to have much impact on the UK economy in the near future, not while the BoE is moving at a snail’s pace.
“Higher inflation could be more negative for the economy, but with wage growth anaemic, it is likely to come from either higher oil prices, or a fall in the pound.”
So what does this mean for the UK?
Economists are not predicting that all will be rosy in the garden when the UK pulls out of its 44-year marriage with the European Union.
Rather, they are claiming Brexit will have a significantly detrimental effect on the economy.
Ratings agency Moody’s knocked the UK’s rating down again, from Aa1 to Aa2 in September.
It had been the first major credit ratings agency to deprive the UK of an AAA rating following the Brexit vote.
Have the ratings agencies got it wrong, however? (It wouldn’t be the first time in recent history).
Not according to economists. In his latest analyst note, Richard Turnill, BlackRock’s global chief investment strategist, predicts a “muted growth outlook” in the UK, primarily as a result of the uncertainty created by Brexit.
He states: “Brexit negotiations in particular are weighing on the UK economy.
“The key to supporting UK investment and business confidence is an agreement on a transition that would cushion the UK’s departure from the EU in March 2019 by allowing the UK to keep trading on existing terms,” Mr Turnill notes.
Pouring vinegar on the wound, in October, the OECD nailed its colours to the mast by telling chancellor Philip Hammond what the UK needed to do if it were to thrive economically post-Brexit.
Speaking at a presentation in London, Ángel Gurría, secretary-general of the OECD, made the point: “The UK is facing challenging times, with Brexit creating serious economic uncertainties that could stifle growth for years to come.”
Investment portfolios and Brexit
Fund managers are definitely concerned. “Brexit [uncertainty] is the biggest risk. Not only could higher Brexit uncertainty cause inflation to rise, but also confidence to fall, reducing business investment, and moving some jobs overseas,” says Mr Zangana.
As a result, he suggests advisers should find out from their clients whether Brexit and sterling are primary concerns for their clients.
“If so, then investors will be more focused on stocks with a greater concentration of their profits coming from overseas,” he says, explaining: “This is because those profits rise in sterling terms as the pound falls.”
With the majority of stocks in the FTSE 100 deriving most of their revenue from overseas operations, this could make the biggest of blue-chips a sensible investment choice for investors.
However, sterling might not be the only thing to suffer if Brexit uncertainty weighs on the economy.
Mr Zangana adds: “But if the UK economy is also a concern, then investing in non-UK markets may make more sense, as these would also rise in value as the pound fell.”
Will domestic stocks suffer? Some consultants are already seeing concerns on this front, particularly from smaller British enterprises, who are calling on the chancellor to back British and provide support for UK smaller companies.
Paul Falvey, tax partner at BDO LLP, comments: “Business leaders are adamant that Mr Hammond should not lose focus on the domestic business agenda during EU negotiations.
“Businesses are keen to see a quick deal on Brexit but do not want the government to lose sight of the importance of UK growth. They want to see the government invest in the future by spending today.”
That said, the government is spending today for Brexit. So far £700m has been spent on Brexit preparations, and HM Treasury is ready to set aside a further £3bn over the next two years – with more to come if needed.
All other economic factors aside, politically speaking, Brexit uncertainty has led to a huge pro-socialist swing in some parts of Britain and created a measure of open revolt among Tory backbenchers just at a time when the government needs to have a unified front during negotiations.
This has caused knock-on effects across the political sphere, which are in turn spilling over into the economic arena and the public sector.
Jason Hollands, managing director of business development and communications at Tilney, explains: “The chancellor went into the Budget with an unenviable hand.
“The government has a wafer thin majority in parliament and has been racked by two Cabinet resignations in recent weeks. There is open revolt on the Tory backbenches and hard core Brexiteers are gunning for the chancellor.
“Meanwhile Brexit negotiations with the EU appear to have hit an impasse and the economy, which proved so resilient in the aftermath of the EU referendum as consumers kept on spending, is facing headwinds as wage growth lags inflation.
“This has piled on the pressure for the government to relax public sector wage constraints, and calls for measures to pacify the younger voters – for example, by looking at reforms to the student loans system, de facto age targeted tax cuts through National Insurance and measures to improve access to the property market.”
Will all this uncertainty have wider effects on inflation and sterling?
The huge devaluation in sterling occurred after the 26 June 2016 vote to leave the European Union. At one point, the pound suffered its biggest fall for 168 years.
On the day of the Budget itself, sterling perked up by a paltry 0.4 per cent against the US dollar, and has finished the week stronger than it started, from 1.32 on Monday 20 November to 1.33 by Friday 24 November.
However, this does not mean the pound is clambering its way out of the woods yet.
Mr Zangana believes more inflation could lead to a fall in sterling, which he says is “more likely to be linked to uncertainty around Brexit”
Yet when the October inflation figures came through, holding at 3 per cent, markets breathed a sigh of relief.
Richard Stone, chief executive of The Share Centre, has called this a surprise: “That inflation held steady at 3 per cent was slightly surprising as many economists expected the impact of sterling’s devaluation following the EU referendum to continue to come through in the figures and drive inflation higher.”
With this background, all eyes were fixed firmly on the chancellor on 22 November to see what tax rabbits he might pull out of the hat to boost British businesses and improve the country’s economic prospects.
He did pledge huge spending on technology and infrastructure, which Schroders head of multi-manager, Marcus Brookes, believes may make these sectors of more interest to investors.
In the Budget, Mr Hammond pledged to expand the National Productivity Investment Fund, which was launched in November 2016, to £31bn from the original £23bn.
The funding, which was set to run until 2021 will now extend to 2022 and will help boost infrastructure and technology developments in the UK.
There will also be a £2.3bn further investment into research and development (R&D), with an increase in the main R&D tax credit to 12 per cent.
Mr Hammond told the House of Commons: “This is taking the first strides towards the ambition of our industrial strategy, to drive R&D investment across the economy up to 2.4 per cent of GDP.”
While the OBR may have been gloomy about GDP growth over the next six years, and expressed concern that the reduction of the deficit has been smaller than it had expected, it also recognised efforts to reduce debt.
Accordingly, the OBR has reduced its borrowing forecast by £3.75bn a year and reduced the debt forecast by between £67bn and £81bn.
Despite this, the office was surprised by Mr Hammond’s stamp duty land tax giveaway to the nation’s first-time buyers, by eliminating SDLT on properties of £300,000 and under, or up to £300,000 on properties in London and the south east, up to a value of £500,000.
“Faced with a weaker outlook for the economy and the public finances, and growing pressures on public services following years of cuts, the government has chosen to deliver a significant near-term fiscal giveaway.
“This adds £2.7bn on borrowing next year and a larger £9.2bn in 2019-2020.”
Inflation and interest rates
The Bank of England also moved to put the base rate up to where it had been at the time of the referendum in 2016. But that slight 0.25 percentage point rise did not do much to alleviate inflation as measured by the CPIH, which stayed at 3 per cent in October.
Mr Zangana comments: “While the (BoE) is not in a rush to raise interest rates again, the latest inflation figures are helpful for ratesetters, especially if inflation now falls back towards the BoE’s 2 per cent target.
“However, the rise in global oil prices in recent weeks could slow the fall in inflation which we are forecasting, and is likely to squeeze households further, keeping GDP growth subdued."
Mr Zangana adds: “Overall, the latest inflation figures show that the depreciation in sterling is still causing prices to rise faster than in recent years. However, this appears to be close to an end.
“Data from producers show that both input and output prices peaked months ago, which should mean that we are close to a peak in CPI inflation.”
Nor did the base rate rise back to 0.5 per cent – the level it has stayed at since March 2009 – do much to alleviate cash savings accounts and Isas.
In fact, one high-street bank wrote to its customers stating that after the bank raised the base rate back up to 0.5 per cent, it was reducing the interest rate on one particular savings account from 0.15 per cent to 0.1 per cent.
Cash savings have been battered for years, by a combination of low interest rates and creeping inflation.
Which areas might do well for UK investors?
The OECD survey, which was unveiled in October, says sustained economic progress will hinge on a successful outcome to negotiations with the EU and those still to come with other countries.
The survey recommends efforts to ensure high value chain integration for network industries and high levels of access for services sectors to overseas markets.
Speaking earlier this year, Mr Gurría said: “Maintaining the closest economic relationship with the European Union will be absolutely key, for the trade of goods and services as well as the movement of labour.
“Macroeconomic and fiscal policy can and should continue being used to support the economy, both during and after the exit negotiations.
“Future prosperity will depend on new reforms to improve job quality, boost labour productivity and ensure that the benefits are shared by all.”
This means infrastructure could be a growth area for investors to focus on, given the government’s pledges to boost this sector of the UK economy.
But as Guy Stephens, technical investment director at Rowan Dartington, comments investors do not seem as concerned as the experts.
He fears that the current high levels of the FTSE 100 might lull some investors into a false sense of security.
Mr Stephens explains: “Even the weakest performing FTSE 100 stock is up by 28 per cent since the Brexit vote, or an annualised figure of 19.2 per cent, surprisingly only just below the S&P 500 at 29 per cent and 20.3 per cent respectively, in USD.”
What is particularly revealing is the annualised returns in the seven years prior to the Brexit vote, starting from March 2009, which marked the index lows following the credit crunch.
For some, this ‘winning streak’ is just too good to break, regardless of the warning signs from the ONS, the OECD and the OBR.
“Fundamentals are ignored and past performance takes on a greater influence, not unlike a gambling addiction,” Mr Stephens dramatises. “I know the odds are I will lose at some point, but I made more money last week, last month, and last year to date, so I will keep on winning for the foreseeable future, until I see that losing catalyst.
“The trouble is,” Mr Stephens adds, “When [that catalyst] arrives, everyone else will also see it, by which time it will be too late.
“Locking in some of these extraordinary gains must be the correct strategy but this goes totally against the psychological tide when returns have been so strong. Timing is everything.”
That said, he also believes there may be opportunity for the brave, especially as the Brexit-related economic outlook “is likely to get worse before it improves”.
While this might mean the UK equity market is off-limits to many international investors – and indeed, the Investment Association UK All Companies sector has seen the highest level of outflows this year – he thinks the contrarian investor will be “increasingly interested in the UK”.
As with everything, diversification is the key to avoiding a heavy drag on the portfolio caused by an overly high exposure to UK domestic-oriented stocks, regardless of Brexit or an uncertain economic outlook.
This is already indicated in the past year, with the Investment Association’s Global Equity sector being the best-seller in two months as investors seek growth outside of the domestic market.
This is not to say the UK is not open for business, but rather one should shop around first.
Simoney Kyriakou is content plus editor for FTAdviser
The House View from Schroders
The economics view
The inaugural Autumn Budget was meant to be a quiet affair when first conceived, but the result of the snap general election earlier this year made this event crucial not only for the government, but for the chancellor himself.
Under pressure to deliver a bold and positive vision of the UK’s future, the chancellor Phillip Hammond started the speech with an upbeat introduction of the economy defying the expectations of more negative forecasts, and promising to face challenges head on, seeking out opportunities.
Unfortunately, the reality of this Budget shows the enormously difficult position the chancellor is in.
Downgrades to OBR’s forecasts
The headline from the Budget will be the large downgrades to the UK’s future path of GDP and productivity growth. The independent Office for Budget Responsibility (OBR) has downgraded its forecast for real GDP growth in each year of the forecast, with nominal GDP 2.5 per cent lower by the end of the forecast horizon.
This naturally led to a higher forecast for borrowing in coming years, with most of the chancellor’s headroom removed.
Measures to support NHS and housing
There was a small net fiscal giveaway in this budget too from the chancellor, with most funding directed towards the National Health Service (NHS), measures to encourage greater investment, and housing.
The NHS and housing had to be targeted by the Treasury as the public considers both these areas to be in crisis. An additional £1.6bn will be given to the NHS next year, well short of the £4bn plus requested by the service.
For housing, £44bn of funding and guarantees will be provided in coming years to support home building, but the chancellor’s well-trailed “rabbit out of the hat” was abolishing stamp-duty for first-time buyers where the value of the home is £300,000 or less outside of London, and on the first £300,000 of a home valued at up to £500,000 in London.
While the chancellor’s efforts to boost housing supply should be welcomed and are long-overdue, the scrapping of stamp duty for first-time buyers (the majority of buyers in the market at any point in time) will likely serve to distort property prices further.
Indeed the OBR has said that it does not expect the policy to help first-time buyers, but to help sellers.
Minimal changes to personal taxes
Personal taxes were largely left unchanged, though personal allowances and the higher tax threshold will be increased from April next year.
The now annual obligatory freeze of fuel duties was delivered, but new levies on diesel cars were announced.
Otherwise, the national living wage will be increased by 4.4 per cent from April, along with the national minimum wage, which now only applies to younger workers.
Overall, this was not the bold, game-changing Budget that many in the chancellor’s own party were demanding. However, Hammond’s giveaways may just about be enough to satisfy the headline writers, and keep him in his job for now.
Azad Zangana is senior European economist and strategist at Schroders
The equities view
Despite the chancellor’s stamp duty announcement and commitment to £44bn of extra funding for the housing market, homebuilders’ share prices were down a little on 22 November.
The Help to Buy scheme, which has been a big support for the sector, is due to end in 2021.
It remains to be seen whether the abolition of stamp duty for first-time buyer purchases up to £300,000 will be an additional boost to the sector, or ultimately replace the benefit that Help to Buy has, until now, provided.
Investors appear to be underwhelmed by these housing market announcements. Until now, homebuilders have been in a great sweet spot thanks to relatively subdued increases in supply, robust demand, low interest rates and Help to Buy.
Shares for the sector are up about 35 per cent over the past 12 months so I think we are now seeing some profit-taking.
Sue Noffke is fund manager, UK equities at Schroders
The fixed income view
The gilt market seems unfazed by the Budget and sterling has held up pretty well.
The OBR growth forecasts have been lowered by more than the market expected and Mr Hammond is being more prudent on the Budget deficit than he might have been.
This is resulting in less likelihood that the BoE will raise interest rates much more (if at all).
In addition, gilt issuance, while a little bit higher than expected from 2019 onwards, isn’t too much to worry about.
The downgrades of the UK’s productivity forecasts are also likely to offset any inflationary pressures from the increases in the National Living Wage, as will the freezing of duty on alcohol and air fares.
Market inflation expectations were a little lower as a result.
Alix Stewart, fund manager, fixed income at Schroders