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The new normal
Views

The new normal

Richard Conway Weekly bulletin August 2019
Bearish views on UK economic prospects are not hard to come by and Friday’s disappointing Q2 growth numbers will have added to the wall of worry. Viewed in the wider international context however, the outlook may not be quite as bad as headlines suggest.
UK GDP growth disappoints (again)

The first contractionary quarter since 2013. The weakest annual GDP growth since the start of 2018. Manufacturing stalling, business investment shrinking, and the dominant services sector barely treading water. Sterling at lows not seen since the Brexit referendum result. The list goes on.

Despite this, UK inflation remains at target (with pressure on the upside), employment is at record highs, real wage growth remains in positive territory and we have a central bank that is openly considering tightening policy in the medium term. The government is in spending mode too. It would make for an odd sort of a recession, this.

The current UK experience is a textbook case for consumption smoothing gone wrong. Firms, households, and even the government were guilty of overly conservative stockpiling in the run up to 29 March. Stock overhangs and surplus supply have weighed on performance since. The broader global growth slowdown will also have had an impact, although these effects are harder to quantify.

Markets saw this coming and the reaction was muted. Gilt yields fell by just 2-4bps across the curve on the release of the GDP figures. The growth slowdown was well signposted by both the BoE and the Treasury.

Perhaps more interesting than these latest GDP numbers is the medium-term outlook and the market’s view on rates.

Negative rates – the new normal?

Negative interest rates, having long been the preserve of economic thought experiments and curveball economics exam questions, are increasingly becoming the new normal.

The entire German sovereign curve out to 30 years now trades at negative rates of return, a consequence of further falls in bund yields over the last seven days. Swiss savers face an even more acute situation, with yields struggling to break -0.25% at any maturity and securities with under 10 years to run barely offering returns more than -1.00%.

Negative rates, while conceptually difficult for policymakers and monetary models, are not outrageous in theory. As Bloomberg points out, paying for a safe place to store your capital is commonplace; depreciation of physical assets, fund management fees, even the cost of a safety deposit box would not cause investors to bat an eyelid. So too, it argues, with government bonds.

A comfortable middle ground

Part of this is a story of supply and demand, with an excess of savers looking for a productive and safe home for their capital. But this is also a story of the outlook for growth. On this level, the UK performs a lot more favourably.

The gilt curve lies about halfway between bunds and treasuries, which most would agree is a comfortable middle ground. US economic growth is running at a considerably faster pace than our own and we are some way off the more deep-seated structural issues at play in the Eurozone.
Expectations at the BoE and the Treasury are for growth to move back to positive territory by Q3, with policy helping to shepherd it along the way and tighten monetary conditions when the time is right.

Mediocrity is, in this case, very much adequate and no doubt Boris and his aides will be happy with this position. There’s plenty more to keep the government occupied before 31 October.

For more information, please contact Richard Conway, Director at JCRA, at richard.conway@jcrauk.com.

 

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