You are using an outdated browser. Please upgrade your browser to improve your experience.

Our views 04 September 2023

JP’s Journal: A tale of two mountains

5 min read

Several of my journal updates in recent months have referenced the slow recovery of the UK economy, pointing out that real output was hovering around the 2019 level. This has now proved to be inaccurate.

Last week, the UK’s Office for National Statistics (ONS) revised previous GDP estimates, resulting in an upward revision for the Covid period, with 2020 growth 0.6% higher than thought, albeit still showing a big decline at -10.4%. Recorded output in 2021 was also taken higher and now shows 8.7% growth. Overall, it means that GDP in the fourth quarter of 2021 exceeded pre-Covid levels and that, barring any further revisions, real output in the last quarter was 1.6% above the fourth quarter of 2019 level, rather than the previous estimate of 0.2% below.

What is outlook for UK interest rates now?

What is the significance of these revisions? It means little in terms on inflation and interest rates but it shows the UK in a more favourable light. For the time being it is Germany that is in bottom place within the G7. More generally, it demonstrates that GDP figures are broad gauges of activity and are subject to revision – although the magnitude of these changes are unusual.

The interest rate outlook took an interesting twist last week with the Bank of England’s Chief Economist Huw Pill using a mountain analogy to show different potential paths for monetary policy. Speaking in South Africa he referenced the characteristics of the Matterhorn and Table Mountain and said that there were different ways to fight inflation via interest rates: “Some of them have rates rising rapidly and falling rapidly in what is sometimes known as the Matterhorn profile. The alternative would be to hold restriction for longer in a more steady and resolute way with a profile for interest rates that looks more like the Table Mountain.” Investors took his preference for the latter to mean that he favoured a lower peak but a more sustained period of higher rates. And, indeed, this profile has been factored into market pricing with a further rate hike expected in September and then rates in the 5.5% - 5.75% area through 2024. Pill re-iterated the commitment to get inflation back to 2%, but markets remain more sceptical with implied inflation, looking at conventional and index linked yields, well above 3% at longer maturities.

This messaging is against a background of potential disappointing UK inflation data later this month. Over the weekend the Chancellor was emphasising favourable longer-term trends but was cautioning on the immediate outlook given the recent bounce in oil prices. Perhaps as an early indicator, last week’s eurozone inflation data was higher than expected, with the August reading of 5.3% being unchanged from July; the consensus was for a fall to 5.1%.

US economy showing strength

The US jobs data showed a mixed picture. The main surprise was the rise in the unemployment rate from 3.5% to 3.8%. Conversely, non-farm payrolls were stronger than forecast with job gains in healthcare, leisure & hospitality, and construction. How do we square the two? As they come from different sources some differences should be expected. The non-farm payrolls figures are provided by businesses whilst the unemployment rate figures reflect a sample of households. However, the rise in unemployment is being driven by an expansion in the labour force rather than job losses, with the participation rate increasing to 62.8%. This picture of increased slack in the labour market without big job losses supports the ‘no landing’ scenario of disinflation and modest growth; a great and surprising outcome if delivered.

The US government bond market sold off after the jobs data but 10-year yields still finished under 4.20%, 15bps below the level of mid-August. In Europe, yields for choice were lower but not by much. In the UK, 10-year rates settled around 4.4%, 30bps off the August high. In sterling investment grade credit, spreads were unchanged, and the recent pattern continues - heavy supply of financial bonds, attractive initial new issue premiums whittled away during the book-building process but still strong investor demand. High yield fared better and spreads fell over the week, towards the lows of the year; from the wides seen in March. My favoured high yield index now shows a fall of over 120bps. Perhaps this reflects the benign ‘no landing’ outlook that is taking hold.

In the UK, headlines were dominated by ‘crumbling’ schools and concerns about Reinforced Autoclaved Aerated Concrete, a concrete used in many public sector building projects. It appears that remediation will have to be undertaken within the existing Education budget. My take is that this is not feasible and will add more pressure to public finances. Since 2010 I count that there have been ten Secretaries of State for Education, with one holding the office for four years; the last nine have averaged less than one year. How can you get long term strategy against this background?


This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.