August 2023 Investment & Economic Update

The FTSE 100 index of leading UK company shares closed at the end of July at 7,699.41 points, up 167.88 points or 2.23% during the month.

Weakening Exports Hit UK Manufacturing

July saw the UK manufacturing sector contract at its fastest pace in three years, marking a year of ongoing decline, according to the S&P Global/CIPS UK Manufacturing PMI survey.

The survey posted a score of 45.3 in July, down from 46.5 in June, representing one of the worst performances since May 2020, and indicating a rapid contraction of the sector. However, this was marginally better than the 45.0 score predicted by analysts.

The data highlighted that firms faced a steep fall in exports, one of the quickest declines witnessed in three years. A weakening global market impacting demand was cited by manufacturers as the key reason for this downturn.

Manufacturing in the Eurozone

July witnessed a sharp contraction in eurozone manufacturing activity, hitting its fastest pace since the early stages of the COVID-19 pandemic, as demand plummeted despite significant price reductions by factories.

Major economic players such as Germany, France, and Italy exhibited significant weaknesses, with the eurozone’s second and third-largest economies showcasing substantial deterioration since June.

The final eurozone manufacturing Purchasing Managers’ Index (PMI), managed by S&P Global for HCOB, dropped to 42.7 in July, down from June’s 43.4, mirroring a preliminary reading and marking the lowest point since May 2020. Any reading below 50 indicates a contraction in activity.

An output index contributing to a composite PMI, set to be released on Thursday and recognised as a reliable economic health indicator, descended to 42.7 from 44.2, a nadir not recorded in over three years.

Inflation Control May Lead to Recession

Alex Brazier, a former member of the Bank of England’s financial policy committee and current deputy head of the BlackRock Investment Institute, warns that the Bank of England may need to induce a recession to return inflation to its 2% target.

Despite the Bank’s 13 consecutive interest rate hikes effectively slowing the economy, Brazier suggests that further increases from the current 5% will be necessary to reduce inflation. However, this could result in weak growth and heightened unemployment.

June’s official inflation data revealed a drop to 7.9% from 8.7% in May, but remains almost four times the Bank’s target. The Bank is not projected to reach its target until early 2025.

Brazier suggested that entrenched inflation necessitates further growth slowdown or even a recession. The challenge for the Bank would be moderating this downturn as much as possible.

He also predicted a peak for interest rates likely below 6%.

Easing Shop Price Inflation

UK retail chains saw their slowest annual rate of price increase this year in July, as per industry data released on Tuesday.

The British Retail Consortium (BRC) reported cooling annual shop price inflation to 7.4% in July, a drop from June’s 8.4%. For the first time in two years, prices witnessed a monthly decline.

The BRC’s inflation gauge, an early indicator for the broader official consumer price index, tracks in-store goods prices, including service and energy costs.

July’s significant downward push in shop prices was largely driven by clothing and footwear, while food price inflation hit its lowest level for the year, according to BRC.

BRC Chief Executive Helen Dickinson expressed cautious optimism, warning of potential supply chain issues influencing retailers’ input costs in the upcoming months. Factors such as Russia’s withdrawal from the Black Sea Grain Initiative and India’s rice export restrictions pose challenges ahead.

Pandemic Debt

Official statistics reveal that the UK’s government debt growth since the pandemic’s onset has outpaced all EU nations except France. The UK’s debt as a percentage of gross domestic product (GDP) escalated from 85.5% in late 2019 to 100.5% early this year, indicating a 15 percentage point leap, according to the Office for National Statistics.

In comparison, the debt burden throughout the EU increased from 77.5% to 83.7% over the same timeframe – a rise of merely 6.2 percentage points, less than half of the UK’s increase.

This signifies that, barring France, where the post-Covid debt-to-GDP ratio growth mirrored the UK’s, Britain’s debt expansion has been the most rapid among EU countries. However, France’s overall burden was notably larger, at 112.4% of GDP at the year’s commencement.

The growing disparity between the UK and the EU, now at 16.8 percentage points compared to eight at the end of 2019, is attributed to extensive government borrowing during the pandemic, weak UK economic growth, and surging borrowing costs.

PwC’s chief economist, Barret Kupelian, underscored the primary divergence factor as the UK’s lack of economic growth, impacting the denominator of the debt-to-GDP ratio.

Gentle Deceleration

UK house prices continued their downward trend last month, with the average price dipping to £260,828, marking a 0.2% reduction, as reported by Nationwide. This acceleration in the annual rate of price drop from 3.5% to 3.8% has not been witnessed since the financial crisis of July 2009.

Despite the prevalent economic headwinds and surging mortgage costs, Nationwide suggests a gentle deceleration in the property market is feasible.

According to Moneyfacts data, current average rates for two- and five-year fixed mortgages stand at 6.85% and 6.37%, respectively.

Addressing the financial strain, Nationwide’s chief economist, Robert Gardner, said: “Housing affordability remains a challenge for those considering buying a property through a mortgage. To illustrate, an individual earning an average wage and aiming to acquire a standard first-time buyer property, assuming a 6% mortgage rate and a 20% deposit, would allocate 43% of their net income towards mortgage payments.”

This figure has risen notably from 32% last year and significantly surpasses the long-term average of 29%. In addition, the deposit requirements remain high, with a 10% deposit accounting for 55% of the gross annual average income.

Despite these difficulties, Gardner remains optimistic, saying, “A relatively gentle adjustment is still feasible, assuming broader economic conditions align with our—and most other forecasters’—projections. Unemployment is forecast to stay under 5%, and the majority of current borrowers should be able to navigate the rising borrowing costs.”

Impending Strain on UK Homeowners

HSBC’s Chief Executive, Noel Quinn, has cautioned that “tougher times are ahead” for UK households as an increasing number of fixed mortgage agreements conclude. He suggested that rising interest rates will increasingly strain UK homeowners, and that the British economic forecast remains uncertain.

Quinn’s warning comes in the wake of HSBC’s profits more than doubling to £17bn. The London-based bank declared pre-tax profits of $21.7bn (£16.9bn) for the first half of this year, a substantial increase from $9.2bn the previous year, largely due to rising interest rates.

Following these substantial results, the bank announced a $2bn share buyback.

Banks on the Clock

The Financial Conduct Authority (FCA) has urged UK banks to justify their low interest rates for savers by the end of August, in line with the new Consumer Duty demanding “fair outcomes.” This follows the finding that just a quarter of recent Bank of England’s (BoE) rate increases have been transferred to popular deposit accounts.

The FCA’s plan includes a biannual analysis of banks’ response to Bank of England rate rises, with regulatory action being possible for non-compliance. While the FCA doesn’t have the power to enforce rate increases, Sheldon Mills, its executive director, has called for quicker progress from banks.

Chancellor Jeremy Hunt backed the FCA’s directive, reiterating that banks should pass on rate increases to savers. Meanwhile, UK’s major banks have denied profiteering allegations. Several banks, including HSBC and Barclays, have recently raised their savings rates in response to the directive.

BP Reports Significant Profit Drop

Oil giant BP announced a more than two-thirds drop in profits over the recent quarter, underperforming expectations. Despite the weaker performance, the company stated on Tuesday that it plans to return more cash to shareholders through increased dividends and additional share buybacks.

The FTSE 100 company reported an underlying replacement cost profit – the company’s preferred metric – of 2.59 billion US dollars (£2 billion) for the second quarter of 2023. This is a sharp decline from the 8.45 billion dollar (£6.6 billion) profit of the same period last year, which was buoyed by a rise in oil and gas prices.

BP attributed the profit decrease to scheduled maintenance work and decreased margins in its refining sector. The announcement comes one week after fellow oil giant Shell reported lower-than-anticipated profits for its latest quarter.

BP stated that the reported performance brings its total profits for the first half of 2023 to 7.5 billion dollars (£5.9 billion).

Global Crude Oil Prices Spike

Oil prices are set to achieve their highest monthly growth since the start of 2022, driven by supply cuts from Saudi Arabia and Russia, leading to a spike in prices.

Both the Brent crude and West Texas Intermediate are anticipated to conclude July with their most significant monthly increases since January 2022.

Brent crude, the global benchmark, is trading above $85 per barrel, marking a 13.7% rise this month. Concurrently, West Texas Intermediate, the US crude benchmark, has exceeded $81 per barrel, reflecting a 16.4% increase for the month.

Supply cuts from major oil producers amidst record high demand are placing upward pressure on oil prices, threatening to tighten the global supply further. Analysts predict Saudi Arabia to continue its voluntary reduction of 1 million barrels per day past August. Furthermore, last month, OPEC+ agreed to restrict oil supply through to 2024.

Russia’s deputy prime minister, Alexander Novak, also announced that the country would decrease its crude exports by 500,000 barrels per day in the coming month.

Market data

£1 buys $1.2820 or €1.1682. Gold is $1,955.55 an ounce, and UK natural gas futures are 71.51p/therm, down from 92.07p/therm at the start of July. The UK 10-year gilt yield is 4.400%, up from 4.111% at the end of April.

Kellands will continue to keep you updated on market developments on a regular basis. However, if you have any questions or need some financial advice in the meantime, please do not hesitate to get in touch.

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