The UK economy briefly looked like it might achieve a ‘not too hot and not too cold’ outcome, but markets are starting to doubt it.
- GDP grew by 0.6% in the first three months of the year
- Inflation dropped to 2.3%, its lowest level in almost three years
- Sterling has moved to a 21-month high against the Euro
For a brief moment, it looked as if the UK economy might just achieve the impossible. Growth would reignite, while inflation would drop, but neither factor would derail an interest rate cut in June or September. However, market jitters soon started to emerge.
There were two pieces of good news in May. GDP grew by 0.6% in the first three months of the year , fuelled by a healthy services sector. This was some way ahead of the Eurozone, which grew 0.3% over the same period, and even ticked ahead of the US. This suggested that the UK was firmly out of recession, and growth could build momentum from here.
The second piece of good news was the inflation statistics. Inflation dropped to 2.3%, its lowest level in almost three years , with cheaper utilities bills and falling food inflation the key factors. Investors were briefly cheered that an interest rate cut was imminent, and would be ‘pain-free’ – it could happen without the UK falling into a significant recession.
However, markets have already started to doubt that scenario. Sterling has moved to a 21-month high against the Euro as traders have started to bet that the UK will lower rates later than the Eurozone. The Eurozone has committed to a rate cut in June, leaving any UK rate cuts likely to be September.
Economists point out that while inflation has been coming down, core inflation (which excludes food and fuel prices) remains at 3.9%, down on a month ago, but still higher than the 3.6% forecast. Headline inflation had been driven lower by the energy price cap and could start to rise again over the next few months.
That said, there are undoubtedly other factors at work in the strength of sterling. The pound has been persistently low since the vote to leave the European Union in 2016 and an imminent change of government also appears to be a factor in its strength. A weak currency has been a factor in the strength of UK inflation and a reversal could help temper CPI.
The ‘happiness window’ has proved brief, but it remains a plausible outcome for the UK economy. Investors have started to believe it may be possible, with the FTSE 100 outperforming the Nasdaq over the past three months. Certainly, there are reasons to be cautious, but valuations for the UK market give plenty of room for manoeuvre.
