July 2023 Investment & Economic Update

The FTSE 100 index of leading UK company shares closed at the end of June at 7,531.53 points, up 85.39 points or 1.15% during the month.

In a last-minute surge, the FTSE 100 managed to end the month positively, although only slightly higher than its May closing.

The London stock market index closed up at the end of June thanks to favourable house price figures reported by Nationwide. Despite this improvement, the FTSE 100 remains lower than its starting point for the quarter, which was approximately 7,632.

CMC Markets analyst Michael Hewson commented on the performance of the FTSE 100, stating that it has been a disappointment, struggling to achieve higher gains compared to the first quarter.

This lacklustre performance can be attributed to weaknesses in sectors such as basic resources, energy, and banks, causing the FTSE 100 to deviate from its European counterparts. The mining sector, in particular, has underperformed due to diminished demand from China.

However, on the positive side, the banking sector experienced a strong session, with Lloyds Banking Group, NatWest, and Barclays benefiting from better-than-expected results in the Nationwide house price survey and the Lloyds Business Barometer survey for June. These reports indicated an increase in house prices and rose to a 13-month high.

Good start to July

European indexes outperformed the FTSE 100 on Friday, with Germany's Dax and France's Cac 40 rising by 1.3%. Similarly, the S&P 500 gained 0.9% in New York, while the Dow Jones increased by 0.6% after the European markets closed.

European stock indices showed modest gains in the first trading session of July, despite Eurozone manufacturing data indicating a decline in output for June. The FTSE 100 in London, CAC 40 in Paris, and DAX in Germany all experienced a 0.2% increase by mid-morning.

Eurozone factory output witnessed its steepest decline since October 2022 in June, primarily due to a significant drop in demand for goods toward the end of the second quarter. Leading the declines were Austria, Germany, and Italy.

In the UK, the S&P Global UK Manufacturing PMI decreased to 46.5 points in June, down from 47.1 points in May 2023, slightly lower than the forecasted 47.2. A figure below 50 indicates a contraction in the manufacturing sector.

The gains in European stocks followed a positive trading day in Asia, where indexes were lifted by the performance of tech stocks.

Emissions limit

Starting next year, a new emissions limit will be implemented for the power sector, energy-intensive industries, and aviation in the UK. This limit will require these industries to reduce their emissions at a pace that aligns intending to reach net-zero emissions.

The announcement is part of a set of reforms introduced by the UK Emissions Trading System Authority (UK ETS), a joint body consisting of the UK Government, the Scottish Government, the Welsh Government, and the Department of Agriculture, Environment, and Rural Affairs in Northern Ireland, responsible for operating the emissions trading scheme.

The UK ETS encourages decarbonisation by facilitating the buying and selling of emissions allowances, which companies must acquire for each tonne of emissions they generate annually.

To facilitate the transition to the new emissions limit, the UK ETS Authority stated that the cap would be set at the upper end of the range proposed during consultations, aligning with the net-zero objective and providing maximum flexibility for industries.

Additionally, extra allowances will be introduced between 2024 and 2027. The current levels of free allocation of allowances for industries have been guaranteed until 2026 to safeguard against international pressures.

Energy forecasts

The head of the International Energy Agency (IEA), Fatih Birol, has warned that energy prices may surge this winter, leading governments to intervene and subsidise bills again.

If the Chinese economy strengthens rapidly and a severe winter occurs, gas prices could rise, placing pressure on consumers. Birol stressed that governments should prioritise energy-saving measures and boost renewable energy sources.

However, a spokesperson for the UK government stated that energy bills are expected to decrease by an average of £430 this month.

The recent increase in gas prices followed Russia's invasion of Ukraine, causing energy bills to rise globally. Several governments, including the UK, introduced support measures to alleviate the impact on households.

The IEA collaborates with governments and industries, providing data, analysis, and policy recommendations. Birol criticised European governments for strategic errors, such as excessive reliance on Russia for energy and prioritising short-term commercial decisions over foreign policy.

Birol cautioned that another spike in gas prices during the upcoming winter could not be ruled out. If the Chinese economy remains robust and increases energy demand during a severe winter, natural gas prices may face significant upward pressure, further burdening consumers.

Recession warning

According to Bloomberg Economics, the Bank of England's efforts to curb inflation may lead the UK into a recession by the end of the year.

Economists Dan Hanson and Ana Andrade predict that if the Bank raises interest rates to 5.75% by November, a year-long recession will occur, erasing slightly over 1% of economic output. This shallow recession could take place just before the next election.

Hanson and Andrade emphasise that there is a risk that the data may not respond as expected to the Bank's actions, potentially resulting in interest rates rising further than their baseline projection. If borrowing costs surpass 5%, they believe the risk of a financial stability shock will increase exponentially.

Bloomberg Economics has revised its forecast for the UK economy, projecting a growth rate of only 0.1% this year and a contraction of 1% in 2024, a significant downward revision compared to the previous estimate of 0.3% growth. However, the forecast assumes that the Bank will raise rates to 5.75% by November, while markets are already pricing in a rate of 6.25% by December, which could lead to a more severe downturn.

The economists highlight the risk of the Bank tightening monetary policy more aggressively than their assumptions. They mention that if the Bank follows market expectations, which imply around 100 basis points higher rates on average over the next three years compared to their forecast, the economy could be 1% smaller by the fourth quarter of 2025, resulting in a deeper recession.

The current inflation rate in the UK stands at 8.7%. Last week, the Bank of England raised interest rates to 5%, reaching a 15-year high, in an attempt to rein in inflation.

Eurozone inflation

The annual inflation rate in the eurozone dropped more than expected in June to 5.5%, primarily due to significant decreases in energy prices. This highlights a growing divergence with the UK, where inflation remains stubbornly high.

Eurostat, the EU's statistical agency, reported that consumer prices in the eurozone increased by 5.5% in the year to June, down from 6.1% in May and below the forecasted 5.6%. Energy prices had the most significant impact on the declining inflation rate, with average prices falling by 5.6% in the year to June, compared to a 1.8% annual decline in May.

Inflation in food, alcohol, and tobacco slowed from 12.5% in May but remained in double digits at 11.7%, putting continued pressure on households facing rising costs for everyday items.

These figures contrast with the UK's high annual inflation rate, which stood at 8.7% in May, the highest among G7 countries. There are concerns that the Bank of England may need to raise interest rates above 6% to bring inflation back down to its 2% target.

Separate data released on Friday showed that the UK had the slowest economic growth in the G7 during the first quarter of the year, apart from Germany, which is currently in a recession.

Energy exploration

Data and industry executives indicate that oil and gas companies are intensifying their search for new deposits, driven by the surge in fossil fuel prices resulting from the Ukraine war.

European majors, in particular, are leading this exploration revival, marking a renewed commitment to oil and gas after Shell and BP backed away from their promises to reduce output and invest in renewables as part of the energy transition.

The shift in focus comes in response to pressure from a majority of investors who prioritise maximising profits from oil and gas rather than investing in lower-margin renewable energy ventures. It also goes against the protests of a minority of activist investors who advocate for greater alignment of oil companies with global climate change mitigation efforts.

This renewed appetite for oil and gas reserves and production represents a significant reversal for BP, which scaled back its exploration unit three years ago. While exploration is a long-term and high-risk business, it has proven to be a more reliable source of profit for energy majors than the distinct business model of renewable energy production.

Big-ticket offshore projects typically require around five years for development from discovery and at least another decade to recoup the initial investment. Despite the risks and timeframes involved, oil and gas exploration remains attractive for companies seeking profitable opportunities in the current market.

Asian slump

Business surveys reveal that Asia's factory activity experienced a slump in June, with sluggish demand in China and advanced nations clouding the outlook for the region's exporters. While manufacturing activity in China expanded marginally, powerhouses Japan and South Korea saw a contraction, indicating that Asia's economic recovery is struggling to maintain momentum.

These surveys highlight the impact of China's weaker-than-expected rebound from COVID-19 lockdowns on the region. Manufacturers in Asia are also preparing for the consequences of aggressive interest rate hikes in the United States and Europe.

While the worst may have passed for Asian factories, the lack of momentum in activity reflects the diminishing prospects for a strong recovery in China's economy. The delay in delivering stimulus measures by China and anticipated pain from significant rate hikes in the US contribute to a gloomy outlook for Asian manufacturers.

China's Caixin/S&P Global manufacturing purchasing managers' index (PMI) dipped to 50.5 in June from 50.9 in May, as reported in a private survey. Although the figure remains above the 50-point index mark separating growth from contraction, the official survey released on Friday indicating continued factory activity declines provides further evidence of China's economic slowdown in the second quarter.

Tesla orders

Tesla Inc announced on Sunday that it achieved a record number of vehicle deliveries in the second quarter, surpassing market expectations. The company delivered 466,140 vehicles during the April to June period, representing a 10% increase from the previous quarter and an 83% increase from last year.

Analysts had predicted an average delivery estimate of 445,000 vehicles, with the lowest estimate at 439,875 and the highest at 450,000. Tesla exceeded these estimates.

The increased deliveries can be attributed to price cuts and US federal credits, which made Tesla's electric vehicles more affordable. The company also produced 13,560 more cars than it delivered in the second quarter, indicating a narrowing gap compared to the first quarter.

House prices

Contrary to expectations, UK house prices experienced a slight increase between May and June, demonstrating resilience in the face of rising mortgage rates, as reported by mortgage provider Nationwide. Property prices rose by 0.1% this month, surprising economists anticipating a 0.3% decline.

Compared to June of the previous year, house prices were down by 3.5%, remaining relatively unchanged from the previous month's figure of 3.4% and performing better than the projected decline of 4% forecasted by analysts. However, this still marked the fastest annual decline since 2009.

Martin Beck, chief economic adviser to the EY Item Club, noted that considering the substantial price gains in previous periods and the challenges posed by increasing mortgage rates and other financial pressures, the resilience displayed by house prices is unexpected.

Market data

£1 buys $1.2674 or €1.1639. Gold is $1,903.55 an ounce, and UK natural gas futures are 92.07p/therm, up from 56.67p/therm at the end of April. 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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