This week’s blog is written by portfolio manager, CJ Cowan.
It’s been a busy week in the UK, with labour market figures, April’s GDP data, and the government’s Spending Review all released. We’ll unpick each of these before looking at what this means for investors.
Tuesday began with a disappointing employment report showing a very large contraction in payroll jobs of 109,000 in May. We think this figure overstates the weakness in the UK labour market, although employers have had to contend with increases in the minimum wage and national insurance since April, so it wouldn’t be surprising if some businesses have shed workers. The report noted that payroll data were gathered earlier than usual, making them particularly prone to revisions.
An adjacent Labour Force Survey reported that the unemployment rate rose slightly to 4.6%. However, this survey has had very low response rates since the pandemic. This probably introduced a negative bias to results as those inclined to respond to surveys may be more likely to report negative experiences. The ONS has made improvements after it briefly stopped publishing the survey in October 2023, but it still advises caution in interpreting the data.
The unreliability of these data sets highlights the difficulties the Bank of England face in getting a good read on the UK economy, and several members of the Monetary Policy Committee (MPC) remain worried that elevated wage growth could re-stoke inflation. However, overall the employment report strengthens the case for further rate cuts, and bond market moves on the day of the release reflected this.
Wednesday brought with it the government’s Spending Review. This was not a major event in terms of overall spending or borrowing as the headline number had already been publicised in March, but the chancellor gave us details of where money would be spent over the next three years. The NHS was prioritised, seeing an average real terms growth of 2.8% per year, while education and defence were up too, with the defence spending set to hit 2.5% of GDP by 2027/8. However, many other departments will suffer cuts.
Rachael Reeves again reaffirmed her commitment to her fiscal rules as she seeks to avoid another ‘Liz Truss moment’. However, she has little room for manoeuvre and the recent reinstatement of the Winter Fuel Allowance is a reminder of the political difficulties of welfare reform, even if it is necessary. It will become very challenging to balance the books if the Office for Budget Responsibility (OBR) downgrades growth, so it looks likely that taxes will rise again at the next budget, which in turn could be expected to negatively impact growth further.
Finally, monthly GDP growth for April was released on Thursday, coming in at a worse than expected fall of 0.3% month on month. While this is not what the chancellor would have wanted, this number looks worse than it is. The UK is one of only a handful of countries who release monthly growth data, and often it is so heavily revised that it is not worth paying much attention to. However, there are still some interesting comments to make.
The UK’s first quarter GDP growth was flattered by an increase in exports as trading partners front-loaded purchases to get them in ahead of US tariff increases. You can see a corresponding effect on US GDP growth, which was negative in the first quarter due to a surge in imports. Both effects will be paid back in the coming quarter, with lower growth in the UK and higher growth in the US to be expected.
Similarly, there was also a surge in house purchases in March to get in ahead of the stamp duty increase at the start of April. This fed through into higher output from professional services that support the homebuying process, boosting growth, but house purchase numbers duly tanked in April once the stamp duty increase came into effect. So, overall, it was a disappointing but unsurprising monthly GDP release, and you shouldn’t take too much notice of monthly GDP growth data anyway!
Sterling has been on a tear versus the dollar so far this year but with growth weakening in the UK and the Bank of England likely to cut rates at least twice before the end of the year, this may not continue. Currencies are a relative game though, and the dollar remains very expensive. If US growth weakens too as expected, then sterling may still have further to run. After all, things in the UK aren’t as bad as the press would have you believe and wages are still growing faster than inflation, but the picture is far from clear.
Gilts appear somewhat cheap relative to the UK’s trend growth rate, but much of this apparent cheapness comes from negative swap spreads – gilts trade with higher yields than equivalent maturity swaps issued by banks. This is not normal and there could be several explanations, but one interpretation is that it is compensation for the bond issuance required to fund the government’s spending plans. Overall, this leaves us slightly positive on gilts compared to other government bonds, but it’s a close-run thing.
Turning to equities, the UK could be a beneficiary of diversification away from the US, but we would expect this to be funnelled into large-cap stocks in the first instance, if it were to happen. There were fanciful hopes last year that a new Labour government might help reignite animal spirits, which seemed to run contrary to party history. However, excessive fiscal spending was a major boost for the US equity market in the post-Covid era so there is some hope the same could happen in the UK as it filters through to corporate earnings.
CJ is a portfolio manager of the Quilter Investors Cirilium and Monthly Income Portfolios. CJ joined Quilter Investors in August 2018 from Aberdeen Standard Investments where he worked in the global macro team, managing global government bond and global aggregate portfolios.
CJ is a CFA charterholder and has also completed the Chartered Alternative Investment Analyst qualification. CJ has a degree in economics from the University of Bristol and an MPHil in Economic and Social History from Brasenose College, University of Oxford.
Testing our mettle
The latest update in the protracted and messy tariff war sees President Trump threatening that the US might yet increase tariffs on the UK’s steel exports to 50% after the 9 July – threatening the UK’s carve out that we thought Keir Starmer had previously negotiated.
But does it actually matter?
