Take the Bank of England’s upgraded UK growth forecast with a pinch of salt
At the start of February, the Bank of England (BoE) upgraded its outlook for growth in 2017, citing stronger-than-expected domestic demand and better-than-expected consumer spending among the reasons for the upgrade. We believe the assumptions behind the improving forecast - especially a further decline in the consumer savings rate - should be viewed with scepticism by investors.
The household savings ratio, the percentage of disposable income that is saved (including in pensions), is driven by a number of factors, including prevailing interest rates and confidence in the economic outlook.
The BoE’s forecasts rely on consumers driving their savings rate to a 50-year low, an outcome we find difficult to believe given the heightened uncertainty as a result of the referendum. Indeed, savings out of available disposable income (i.e. excluding employment-related pension schemes) are already negative - though this is not unprecedented (a similar situation was seen between 2001-7) we think this tests the credibility of the Bank’s assumptions.
Weaker real income growth and a less certain outlook
Recent BoE forecasts also highlighted the belief that nominal wage growth would slow in 2017, while inflation is rising, leading to a sharp reversal in the positive real income growth seen over the past couple of years. The impact of this reversal of real income growth will hurt consumer spending (illustrated by weaker-than-expected UK retail sales figures released today), while business investment is likely to remain impaired by uncertainty around future trading relationships. To us, the risks around the Bank’s latest upgrades are significantly skewed to the negative side.
Impact on markets
Going forward, uncertainty created by Brexit and underlying growth dynamics should continue to be the driving force behind valuations of UK financial assets and sterling. Though sterling has already depreciated significantly, our view that the economy will slow significantly in 2017, which the market no longer discounts, means we retain our negative view on the currency. We also see opportunities in expressing this negative view in the UK economy through being long gilts, but our conviction remains that shorting the currency is the cleanest expression of our view.