ISQ - April 2024
Key Takeaways
Having spent several years in the doldrums, the UK economy is slowly turning a corner. Business surveys are pointing to a slow revival in confidence in the future and households should benefit from near-term fiscal policy easing, rising disposable incomes and an improvement in the housing market.
The Chancellor’s Budget delivered a modest net giveaway of £13.9bn in the forthcoming fiscal year and shadow Chancellor Ms Rachel Reeves has committed a possible future Labour Party administration to working within the constraints imposed by important fiscal discipline.
The Bank of England, in response to an already apparent fall in inflationary pressure, with the strong likelihood of a further deceleration to come, has signalled its intention to lower interest rates before very long and once the process starts it will likely continue over the remainder of 2024 and on into 2025.
The outlook for the UK’s financial markets is improving. Sterling is well supported by rising investor conviction in improving prospects and the growing expectation that inflationary pressures will continue to fall fast in coming months. This same conviction should underpin the gilt-edged market while a steady, if shallow synchronised improvement in the global economy should provide ongoing support for the stock market.
After two negative quarters of economic activity over the second half of 2023, the UK outlook is beginning to improve. Following two years of stagnation GDP finally contracted by 0.5% over the final two quarters of last year confirming, in so doing, the shallowest recession on record in response to the lagged impact of earlier high inflation and the Bank of England’s aggressive rate hiking programme to bring those price pressures back under control. While their lingering impact continues to act as an anchor on economic activity, forward-looking business surveys are already providing a glimmer of hope that the worst of the economy’s travails might now be over. Furthermore, the Chancellor of the Exchequer’s March Budget delivered a net giveaway of £13.9bn (0.5% of GDP) which should help to strengthen the recovery, in the near-term at least. With inflationary pressures now on a clearly decelerating pathway, the Bank of England’s interest rate-setting Monetary Policy Committee used its March meeting to deliver a heavy hint that the country’s central bank is almost ready to lend a helping hand in the form of lower interest rates in coming months, easing the pressure on businesses and providing a welcome boost to households’ real incomes. Reviving confidence in the outlook is already in evidence in the financial markets. Having lagged other international stock markets over 2023, the UK’s index of 100 leading companies has hit its highest levels in a year and is not far away from the all-time high levels recorded in February last year, while the more domestically focused Mid-250 Index has also delivered a spirited revival. The gilt-edged market has found the going challenging this year, after making good gains at the end of last year, but here too prospects are brightening and future investment returns are likely to be positive. Sterling has proved resilient on the foreign exchanges, in part a function of the slowly strengthening outlook and in part the market’s expectation that UK disinflation will outpace that of other developed economies in the months ahead.
After months in the doldrums, an increasing number of forward-looking business surveys are beginning to point to a slow revival in confidence in the future. While the UK economy stagnated over the past couple of years, business investment proved a beacon of light amidst the otherwise gloomy backdrop. Buoyed by an ongoing improvement in transport equipment, business investment increased by 3.7% over the year to Q4 2023 and the promise of lower interest rates should further enhance confidence in coming quarters. More broadly, the UK’s housing sector is one of the most sensitive to interest rates and here too falling mortgage rates since the start of the year signals strongly that the drag imparted by the higher interest rates of the past is beginning to fade, to be replaced by increasing levels of residential investment in coming months. Using the platform provided by the recent annual Mais Lecture in the City of London, the shadow Chancellor Ms Rachel Reeves sent a strong signal that a future Labour administration would not seek to undermine these fragile green shoots were the opposition Party to emerge victorious at the forthcoming election.
The Chancellor of the Exchequer, Mr Jeremy Hunt, delivered a modest net giveaway of £13.9bn in the 2024/25 fiscal year at his recent Budget, an easing in the near-term fiscal outlook almost entirely down to tax cuts and achievable, according to data supplied by the Office for Budgetary Responsibility, largely due to lowered market expectations for interest rates going forward. In consequence, real GDP growth forecasts were revised higher, from 0.7% to 0.8% in the current year and from 1.4% to 1.9% next year. To be clear, despite the Chancellor’s overt efforts to deliver a pre-election boost to economic activity, the ongoing commitment to fiscal policy responsibility leaves an estimated cumulative £86.0bn (3.2% of GDP) of future fiscal tightening in the pipeline by 2028/29, a notable constraint on potential future policy initiatives irrespective as to which party emerges triumphant at the polls.
Were the Labour Party to win an election that must be held before end-January 2025, the shadow Chancellor has pledged a continuing commitment to fiscal policy discipline whilst nurturing the fragile green shoots of economic recovery as best it can. The job for whichever party wins the election will be made harder by the strong likelihood that the neutral rate of interest in the future will be higher than that prevailing in the period prior to the onset of the pandemic. Having averaged c.2.0% of GDP over 2010 -2019, the UK’s average debt interest bill is likely to increase to around 3.0% of GDP over the next five years, a clear indication that, for whatever grandiose plans might make their way into forthcoming manifestos, the scope for a more expansionary fiscal policy will likely prove very limited. Given that all political parties have pledged ongoing support for the health service and for education, any additional expansion of the role of the state may very likely require additional tax increases to cover a further rise in spending.
In response to an already sharp fall in inflationary pressure from the peak levels of autumn 2022 and the prospect of a further deceleration in the very near future, the Bank of England is finally preparing the way for lower interest rates in the months ahead. At the conclusion of its March rate-setting meeting senior officials on the Monetary Policy Committee elected to hold the base rate steady for a fifth consecutive time at 5.25%. Importantly, it accompanied the decision with the strongest signal yet that interest rates are coming down starting, if financial futures market pricing is correct, in the early summer. Three key developments underpin the growing belief that the Bank is set for turning: Firstly, for the first time since September 2021 none of the 9-member Committee voted for a rate hike (and one member is now voting for a rate cut already). Since the Bank overhauled its rate-setting process in 1997 never once has there been a rate cut when at least one member has voted for a hike. Secondly, the meeting’s accompanying minutes strongly inferred that policy could be loosened even though the desired 2% inflation target has not yet been reached, providing that price pressures are deemed to be falling sustainably towards that level. Thirdly, the Bank’s Governor, Mr Andrew Bailey hinted strongly in a Financial Times article that all future meetings should be considered “live”, an indication that rate cuts will likely form a key focus of future discussions.
Just as significant, the first rate cut in the cycle will very likely be followed by more, perhaps down to adjusted estimates of where the future neutral rate – the level thought consistent with price stability at given levels of economic output – might be. The working assumption at this stage is that a base rate of interest at or around 3% could prove the target in 2025. Supported by an anticipated sharp fall in both services inflation and wage pressures, it is thought possible that UK CPI inflation could fall both to and then through the 2% target in the months ahead, and stay there not just through 2025, but 2026 too. Were such an optimistic outcome to be achieved it would take UK inflation well below forecast levels in both the eurozone and the United States over the same period.
The fact that the Bank of England is, for now, unwilling to cut interest rates has resulted in the emergence of extremely restrictive monetary conditions. Real interest rates (those prevailing after adjusting for inflation) are extremely high, imparting a significant headwind to economic activity were levels to be sustained for any length of time. That they are not thought likely to be sustained has resulted in a substantial increase in financial market speculative activity in support of the pound. This speculation has recently hit a five-year high, according to Bloomberg, a notably higher level than all other currencies featured in the analysis. Financial market pricing implies strongly that real rates (especially in relation to the United States) will both remain high and keep rising as UK inflation falls sharply over the spring. Only an aggressive rate cutting programme, such as that outlined above, could prove sufficient to topple the pound and even then improving growth prospects relative to developed economy counterparts could limit the extent of any potential weakness.
Having given back some of the gains achieved at the end of 2023, the UK’s gilt-edged market is looking a much more attractive proposition for both domestic and international investors in the light of the outlook highlighted above. The combination of sharply falling inflationary pressure and the onset of a notable and prolonged period of rate cuts should allow yields to fall sharply going forward, augmenting positive returns to investors holding broadly diversified asset portfolios.
Driven by improving investor confidence in the outlook for the UK and the global economy more generally, stock markets are likely to build on the already strong gains achieved over the past five months. The UK’s leading index of 100 companies has lagged that of major developed economy counterparts, but signs are growing that that underperformance might now be coming to an end. Index constituents, heavily weighted to the Pharmaceutical, Oil & Gas, Basic Resources and Banking Sector, derive in excess of 70% of their earnings from outside the UK and would clearly benefit from a general improvement in operating conditions. The more domestically focused index of 250 companies should also encourage support given the greater cyclicality and interest rate sensitive nature of many incorporated businesses.
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APPROVED FOR CLIENT USE
Black MondayOn 19 October 1987, the stock markets experienced a dramatic plunge that prompted many firms to shut down their trading desks and turn off their phones to minimize internal losses. Raymond James refused to do the same. Our desks stayed open to help meet clients’ needs, resulting in our first and only unprofitable quarter since the firm went public in 1983. |
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Who was Raymond James?The Raymond in our name is actually from Edward Raymond, owner of a 15-employee mutual fund sales group, Raymond and Associates, along Florida’s west coast. He sold his company to Bob James on 15 July 1964, on condition that the surviving firm be called Raymond, James & Associates. Three days after the sale, Ed Raymond was involved in a near-fatal automobile accident and never joined the firm. Nonetheless, even after Raymond had passed away, Bob James insisted that his name remain on the door – ahead of James’ own. That was a promise he made to Ed Raymond three days before the accident, and Bob James was a man who kept his promises. |
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Bear Market of 1974The severe bear market of 1974 threatened the existence of Raymond James, which was bleeding capital by the day. Tom James, his father and other leaders took extreme measures to keep the firm afloat, slashing costs, foregoing paychecks and even attempting to sell the firm for just enough capital to protect client assets and retain as many associates as possible. The story could have ended very differently if not for a sharp upturn and continued rebound in the stock markets late in the year. |
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Taking Raymond James PublicWhen consideration was being given to taking Raymond James public, Tom James penned a letter to shareholders (largely employees at the time). ” … the public offering should be considered as a statement of our independence. While this is a psychological rather than an economic rationale, it is nonetheless very important. We have asserted for some time that we are not interested in becoming a small part of a very large corporation. That assertion results mainly from the inclinations of management rather than the economic benefits associated with either alternative. The public stock offering affords us the opportunity to enjoy a little bit of the best of both worlds. While shareholders will be given liquidity at fair market value, we will still have the ability to control our own destiny.” After 40+ years of Tom’s leadership, upon becoming CEO, Paul Reilly was often questioned about whether the company might ultimately surrender its cherished independence and be acquired by some larger entity. His response: “Not while I’m around.” It’s a theme that continues today. |
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