Written by Sophie Lund-Yates, Lead Equity Analyst at Hargreaves Lansdown
The UK’s economy rose 0.3% in January, as services returned to growth – including arts and entertainment. Household spending has been holding up much better than expected despite soaring inflation, and this is propping services up.
However, in the three months to January, GDP was flat and the construction sector is facing reasonably sharp contractions. This tallies with the idea that the UK economy is going to shrink overall this year, even if a technical recession is avoided. The takeaway for businesses is unfortunately that things are going to remain very challenging, with stagnation a likely scenario for some time.
The UK’s economy is the only one in the G7 to be below its pre-Covid size, which is a badge the government would really rather not have as it pushes its high-growth agenda. There are a few reasons for this, and a lot stems from the UK’s specific labour shortage. The UK is down around 500,000 workers because of Brexit and the pandemic, and filling the gaps in the areas of the economy these have left is very difficult and has direct consequences for the economy’s ability to grow.
Skills shortages keep wages higher for longer, which feeds into higher inflation. The soaring costs being faced by consumers and businesses are likely to be more difficult to bring down than in the US and this also makes economic expansion a very tough task. The better news is that while the UK is facing slow growth at best and contraction at worst, we aren’t facing a financial crash. Economic activity will slow and that will cause pain for some corners of the economy, but a full-scale financial wipe-out isn’t on the cards as things stand.
Spiralling costs on HS2 means the high-speed rail line will be delayed by two years. Infrastructure projects of this scale always come with execution risk, but there’s a real possibility that prices could be even higher down the line. The development also raises questions for the multiple companies involved, whose margins are traditionally already very thin. There should be less friction for the UK’s growth attempts when the line is complete because the aim is to open up northern economies and stimulate activity, and on that front the delays are highly disappointing.
The Stoxx 600 and major US indices have been taken into the red, as markets weigh comments from Jerome Powell which suggested the Federal Reserve is prepared to hike interest rates at a faster rate than expected. Expectations for a 50bp increase are now largely heightened. The trajectory of interest rates will depend on how hot economic data is, especially around core inflation, as costs around housing have been stubbornly difficult to bring down.
The latest comments from the Fed don’t amount to new information, but they’ve highlighted the lack of certainty around central bank policy, and markets dislike uncertainty more than they like hardship. A catalyst for upwards movement in global markets would be a weaker US jobs report today, which would act as a clear marker that core inflation could start to come down in the US. While the February jobs report is expected to show that hiring slowed from January’s large gain, a strong report will put further pressure on equities.
The market could be spooked if it believes rates could reach the 6% mark, which would deepen recession fears and is a large reason we’ve seen US financials come under heavy pressure in recent trading. More broadly, recent developments have heaped further challenges on stocks that are viewed as overvalued, and UK and European valuations continue to trend below longer-term averages.
Brent crude is down to $81 a barrel, dropping more than 5% this week. The declines are a direct consequence of Fed comments, which have raised questions about economic growth and recessionary risk. A larger slump hasn’t been seen as the market assess the growth outlook for China now that the economy has reopened, and modest growth targets in the region remain intact.