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Sterling to suffer as UK ‘limps towards recession’

Longview Economics 08-Jun-2018

The UK is one of the most vulnerable major economies and may be among the first to see cracks as central banks tighten, according to Longview’s Harry Colvin

The UK’s economy could signal an early warning of the next global recession. Being one of the most vulnerable major economies to monetary tightening it may be among the first to see cracks emerge, according to Harry Colvin, senior market strategist at Longview Economics.

Sterling’s direction has been driven by Brexit sentiment since the referendum vote in 2016,but as the recession risks become more apparent, Colvin says, there would be expected weakening of the currency, as would further rate rises from the Federal Reserve (Fed).

UK one of the worst

The UK is particularly vulnerable to retrenchment by households triggered by tighter monetary policy or falling house prices, the Longview strategist says. ‘ The UK has one of the worst economic models in the western world,’ which hasn’t been helped by ten years of cheap money leading to ‘no real wealth creation in this cycle’.

The outlook for interest rates, particularly in the US, feeds through to the UK.  As the bond yield curve flattens, in other words the rate on 2-year bonds gets closer to that on 10-year bonds, interest rates on personal loans and such climb. This is hitting UK consumers' disposable income and, consequently, consumption. The same can be said for the weaker pound, which imports inflation. Money supply figures are also suggesting banks are less able or more reluctant to lend.

Bank of England rates decision

The Bank of England (BoE) Monetary Policy Committee (MPC) meets later this month with the latest interest rate announcement coming at midday on 21 June. Despite Ian McCafferty, one of the two hawks on the Bank’s MPC, arguing for an immediate rate increase, no rise is expected this month. Market expectations are for just one hike this year, with a 56% likelihood that there will be a quarter percentage point rise at the August MPC meeting when the latest inflation report is also due. That would take interest rates to 0.75% from their current 0.5%.

McCafferty argues raising rates too late will mean sharper hikes to curb inflation. Colvin says the BoE is stuck between undermining consumption if it doesn’t raise rates and undermining credit growth and house prices if it does.

Recession a little way off

Colvin doesn’t expect a recession in the next year but does see the UK as the canary in the economic mine warning of a wider global downturn. It is worth keeping an eye on would-be housing and credit related data, like those on mortgage applications and money supply.

Topics: UK economy, central banks, sterling