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Our views 19 February 2024

JP’s Journal: Call this a recession?

5 min read

Last week saw data showing that the UK was in recession in the second half of 2023. It was an outcome that I had expected, reflecting the rapid rise in interest rates and the squeeze on disposable income following the inflation spike. But, in reality, my forecast was awry.

The recession that I feared was a sharp drop in activity and this has not happened. Q4 output was down -0.3%, lower than the expected -0.1%. Coupled with the 0.1% contraction in Q3 it meant that the UK recorded two consecutive down quarters. For 2023, the Office for National Statistics estimate that the UK economy grew by only 0.1%. Basically, the economy is flat lining, with little growth since late 2021.

A breakdown of the latest quarterly data shows that net trade was a big drag, with a significant decrease in exports. Surprisingly, business investment was a relative bright spot. Indeed, business surveys suggest a small recovery in private sector output from here with both the December and January UK composite Purchasing Managers’ Index above 50. With the labour market showing stronger-than-expected job gains last month, and strong January retail sales, there are tentative signs of a pick-up. Does a recession in H2 2023 change the interest rate outlook? No. Market pricing shows base rates between 4.25% and 4.5% by year end, being little changed over the week. Recession can be more about headlines than changing the interest rate dial.

On the subject of trade and its impact on UK growth, Goldman Sachs published research last week estimating that Brexit has resulted in a 5% relative loss of GDP. The biggest factor was weak exports. The Brexit narrative that it would be easy to replace lost opportunities in the euro area with free trade agreements on a global basis has proved to be illusory – even with Anglophile countries. Business investment is seen as another casualty, reflecting the prolonged uncertainty about Brexit arrangements. The labour market impact has also played a part according to Goldmans. Rather than reducing immigration, the post-Brexit world has seen a large increase, with a significant compositional change. A sharp drop in European citizens coming to work in the UK has been offset by a larger increase in non-EU migration, particularly those coming to study. This may herald long-term benefits but the short-term impact is tighter labour market conditions. Indeed, Goldmans reckon that this is one factor in the UK’s poor inflation performance.

Of course, real GDP is just a measure – and one that is often misunderstood. It is not a gauge of average UK living standards. It takes no account of distribution: growth may be concentrated in certain socioeconomic sectors or geographical areas. It can be distorted by short-term economic policies that have longer term consequences (like maxing out on your credit card and thinking you are wealthier), but most particularly because it ignores the size of the population. Real GDP growth is a product of workforce change and productivity. In reality, whilst the UK population has risen, due to net immigration, the workforce has not grown, largely reflecting to the significant health crisis we now face, with nearly three million people inactive due to well-being issues. Meanwhile the productivity growth rate, despite the much heralded tech revolution, has declined, averaging just 0.7% since the financial crisis and a far cry from 2% trend in the preceding period. Real GDP per capita is going the wrong way.

With US data being generally positive in recent weeks, the trend of higher government bond yields continued. Rates on 10-year US treasuries closed just below 4.3%, 40 basis points (bps) higher than at the beginning of the year. This six-week move has been mirrored by German yields, where the 10-year settled at 2.4%. In the UK, the 10-year gilt yield has risen by 60bps since the New Year, with the rate closing last week at 4.1%. Implied 20-year UK inflation has remained broadly unchanged in recent weeks, despite the better inflation data. With real longer dated real yields back above 1.3% there is emerging value in index linked gilts.

The story in credit remains unchanged. Strong demand across both investment grade and high yield markets pushed spreads lower on the week. Annuity buyers at medium and longer dated maturities is a recurring feature, with a particular focus on more highly rated benchmark issues. In sterling, supply has been increasing but not at the anticipated rate, resulting in a strong bid in the secondary market. Elsewhere, US dollar issuance is high but is being absorbed well by investors.

Overall, financial markets seem relaxed about economic trends. As someone on the more pessimistic end I have to acknowledge the resilience, in spite of the headwinds of tighter monetary policy and inflation. But for me the longer-term outlook seems increasingly challenging. I think those index linked gilts could be a good hedge.


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.