investment insights
Can the UK’s recovery offer long-term momentum?
Lombard Odier Private Bank
Key takeaways
- The UK’s vaccination rollout has accelerated economic expansion. The BoE raised its 2021 GDP forecast from 5% to 7.25% this year
- The country’s economic recovery is ahead of its nearest neighbours and trade flows have improved
- Brexit-related challenges persist, and recent elections highlight the potential risk of Scottish independence and a UK breakup
- We remain overweight UK equities, which are poised to benefit from the recovery.
A successful vaccination programme and a re-opening economy bode well for the United Kingdom’s pandemic recovery. The country is enjoying a momentum that will need sustaining through longer-term political and economic challenges coloured by Brexit and relations with its biggest trade partners.
Europe’s most efficient vaccination rollout turned around the UK’s prospects for expansion this year. In 2020, the UK suffered the worst Covid-19 mortality and infection rates in Europe and its economy shrank by almost 10%. More than half of the UK population is now vaccinated with at least a first jab, outpacing Germany’s 32%, France’s 26% and Switzerland’s 23%.
Weeks after emerging from its third pandemic lockdown, the UK plans to have fully reopened its economy in June. The Bank of England now expects the British economy to expand by 7.25% in 2021, with unemployment hitting a peak of 5.4%, compared with its previous forecast of almost 8%. Household spending in the UK fell more than 10% last year, leaving an estimated extra GBP 200 billion in consumers’ pockets. Unleashed, that would create the biggest British spending boom in more than three decades.
As a result, the BoE sees the UK returning this year to pre-pandemic economic levels of late 2019. That is one quarter earlier than previously estimated and a faster recovery than the European Union’s forecast GDP growth of 4.0% for 2021. Of course, it is worth remembering that an economic re-opening can only offer a one-off boost to growth. High-frequency data, measuring an average of indicators including mobility, business activity and trade data, shows the UK economy recovering more quickly than its EU neighbours (see chart).
The BoE upgrade provides the first step in policy adjustment, raising the likelihood of higher borrowing costs by mid-2023, from the current historic low of 0.1%. In line with market expectations, the BoE also rolled back its bond-buying market support by GBP 1 billion, to GBP 3.4 bn per week. The central bank remains committed to GBP 150 bn of fixed income purchases through 2021, accompanied by low interest rates.
Even if this proves to be the fastest recovery since 1945, following the biggest slowdown since 1709, BoE Governor Andrew Bailey pointed out that this still amounts to almost two lost years of economic growth.
Longer term, the UK faces a rising budget deficit as tax receipts fell through the pandemic, in line with the decline in economic growth, and the government stepped in to support the economy. As a share of gross domestic product, UK government borrowing reached 16.5% in 2020, the third highest among advanced economies, behind the US and Canada, according to International Monetary Fund forecasts. The UK’s Office for Budget Responsibility expects that the country’s deficit will reach GBP 355 billion for 2020/21, or 17% of GDP, which it said in March would be “a peacetime record.”
Post-Brexit trade
Since transition trade arrangements ended on 1 January 2021, trade flows have slowed. February trade data, the latest available, shows that the UK exported goods worth GBP 11.9 bn to the EU, and imported GBP 16.6 bn. In comparison, the UK exported GBP 14.8 bn in February 2019, before Brexit and the 2020 transition period, and imported goods worth GBP 23.4 bn.
Many of the Brexit issues have been specific or regional. There are still problems within sectors such as exports of dairy and fish products and delays in trade between Britain and Northern Ireland, which shares the country’s only land border with the EU. The eventual costs or benefits of divergence between UK and EU standards post-Brexit will only become clear once the pandemic is past.
In the meantime, tensions continue to surface. Most recently over access to the fishing grounds surrounding the UK crown dependency of Jersey, which sits 22 kilometres from the French coast. Last week the British and French governments both dispatched naval vessels to police a dispute over access to fishing rights. The frictions, which coincided with the biggest elections in the UK since the general election in December 2019, blew over within a day, after a demonstration by French fishing boats.
UK elections
The results of the EU referendum more than five years ago have revived political debate around fuller Scottish or Welsh independence and discussions over the future of Northern Ireland.
Last week’s UK elections for the devolved Scottish parliament, Welsh assembly, 143 English councils, a series of city mayors and one member of the Westminster Parliament saw around 50 million people eligible to vote. The Conservative government increased its parliamentary majority, winning one seat previously held by Labour.
In Scotland’s Edinburgh-based parliament, the Scottish National Party (SNP) won 64 seats, one short of a majority. Still, including the Green Party’s eight seats that gives independence supporters a 15-seat majority in the 129-member chamber. While the SNP claims a mandate for a second independence referendum, both sides of the debate have agreed that pandemic is the priority for now. Therefore, another independence referendum is not an immediate political risk, but pressure for a vote will intensify throughout 2022.
UK asset outlook
The strength of the UK’s recovery is a direct result of its rapid vaccine rollouts. The momentum identified last week by the BoE’s outlook now depends on political support and vision for a re-booted economy built on renewed relations with its nearest markets and the rest of the world. In the medium to long term, the risk to economic momentum includes the threat of even deeper political upheaval.
The UK’s political risks will play out in currency markets, with any instability visible in sterling weakness against the dollar and euro. Given its value-oriented stock market, we favour UK equities, which should benefit from improvements in global trade flows and as cheap sectors such as banking and energy catch up with the recovery reflected in the wider market.
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