Weaker pound starts to bite UK consumers - J.P. Morgan Asset Management
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Weaker pound starts to bite UK consumers

Contributors Stephanie Flanders, Global Markets Insights Strategy Team

In brief

The UK economy consistently beat expectations in the months after the European Union (EU) referendum - but not any more, with growth figures for the first three months of 2017 showing the slowest pace of expansion since the start of 2016. The estimated 0.3% rise in GDP in the first quarter is half the pace of the previous three months and significantly lower than expected. There is no imminent risk of recession but clearly higher inflation as a result of the weak pound is starting to squeeze consumers. The key issues to watch for the rest of the year will be whether, and to what extent, weaker domestic activity is offset by higher net exports, and what is made of all of this by the Bank of England.

What happened?

  • The 0.3% estimate for the first quarter of 2017 is less than half the 0.7% rate recorded in the fourth quarter of 2016, with the change entirely due to the services side of the economy, which expanded by just 0.3% compared with 0.8% in fourth quarter. Output from consumer-facing sectors, such as retail sales and accommodation, declined, which the statisticians put down to prices rising more than spending.
  • The pound fell against the euro but rose slightly against the US dollar, while the FTSE 100 fell slightly and Gilt yields rose.

Analysis

Most economists were wrong about the short-term economic impact of the vote to leave the EU last summer, leading to a steady upward revision in UK growth forecasts. The Bank of England aggressively joined the club in February - with a 2% growth forecast for 2017 that struck many as over-optimistic, incorporating a 0.6% growth number for the first quarter. The central bank will almost certainly have to revise that down in its next report on May 11.

Members of the Monetary Policy Committee, who have been concerned about the impact of higher inflation on consumption, will feel partly vindicated by the lower GDP report, as well as other signs of weakening activity, including two consecutive months of falling house prices in March and April and recent weakness in retail sales and consumer confidence.

Investment implications

The UK economy is still growing and there is every chance - in the short term - that UK exporters will benefit from improving growth in key European markets in 2017. But today's data confirms that the domestic economy is not going to be unaffected by the sharp fall in the consumer's purchasing power in world markets. The world is a lot more expensive for UK consumers than it was a year or two ago, and the household savings rate is already extraordinarily low. Investors should remember that global growth is good for the UK equity market, with companies earning two thirds of revenues overseas. But this is probably no time to make big bets on domestically oriented sectors, while talk of early rate rises in the UK looks premature.

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