Market/Economic Analysis: U.K.

Includes: EWU
by: Hale Stewart

The U.K. has one fundamental problem: incredibly weak GDP growth. Here are two relevant charts:

The top chart shows the overall level of GDP, which shows the U.K. economy's overall level of GDP is still below its pre-recession peak. The second chart shows the reason for this slow growth: it has had five quarters of Q/Q GDP contraction.

The main culprit has been a continued decline in manufacturing and, as a result, investment:

The top chart shows manufacturing has contracted in six of the last seven quarters while the top chart shows a continual decline in manufacturing.

As a result of manufacturing's decline, there is no need to make capital investments. Hence we see that gross fixed capital formation has declined in five of the last eight quarters.

However, there are signs that overall activity may be picking up. The following is from the Bank of England's latest policy minutes [pdf]:

13 The preliminary release of Q1 GDP had shown a 0.3% increase, all of which had been accounted for by the services sector. In line with the usual pre-release arrangements, the Governor informed the Committee that industrial production had risen by 0.7% in March, on the back of a 1.1% increase in manufacturing output. The level of production in February had been revised down, however.

Nonetheless, the pattern of growth over Q1, together with the increase in the April CIPS/Markit indices, suggested that the level of overall activity at the beginning of the second quarter was likely to have been higher than the Committee had previously anticipated, and Bank staff’s projection for the

preliminary estimate of Q2 growth was 0.5%, although there was a sizable margin of error around such a forecast. Looking further forward in 2013, there was the possibility of a stabilisation in oil production in the North Sea and in the output of the construction sector.

14 Recent indicators of expenditure had been broadly positive. Retail sales had risen on the quarter and, accounting for seasonal factors, there had been a 16% increase in new private car registrations in the three months to April compared with the previous three months. Broad money holdings of the corporate sector had increased by around 10% at an annual rate in Q1, perhaps as a prelude to greater business investment. And, in line with the usual pre-release arrangements, the Governor informed the Committee that both imports and exports of goods had risen strongly in March.

As the GDP chart above shows, consumer spending hasn't been a problem. It's been positive for the last six quarters. Manufacturing has been the economic stick in the mud. But that might be changing. First, is the news from the Markit survey

The U.K. manufacturing sector continued its positive start to the second quarter of 2013. After returning to growth in April, May saw operating conditions improve at the fastest pace in over a year, with growth of production and new orders both accelerating. The domestic market was the main driver of new order inflows, although new export business also contributed with a modest increase.

At 51.3 in May, up from a revised 50.2 in April, the seasonally adjusted Markit/CIPS Purchasing Manager’s Index® (PMI®) posted its highest reading since March 2012 and remained above the neutral 50.0 mark for the second straight month.

The expansion of manufacturing output was broad-based in May, with growth registered by the consumer, intermediate and investment goods sectors. The strongest performance was seen at consumer goods producers. U.K. manufacturers generally linked higher output to improved new order inflows, successful new product launches and efforts to clear backlogs of work.

Here are the charts from the report:

The top chart shows that the overall Markit number has again moved into positive territory. However, it is the lower chart that shows all three manufacturing sectors -- consumer goods, investment goods and intermediate goods -- are again printing in positive territory.

This is corroborated by the latest U.K. manufacturing report. Although the latest numbers show a .2% drop, this followed two months of increases:

Despite the April fall, the figure is stronger than it was at the start of the year and provides an early indication that manufacturing output, which makes up just over 10 per cent of the economy, will lift GDP in the second quarter.

“The fall in manufacturing output does follow large rises in February and March and the underlying position is probably one consistent with some small forward momentum,” said David Tinsley, U.K. economist at BNP Paribas, a bank.

Let's turn to the U.K. charts.

Overall, the U.K. ETF is still in an uptrend. There are two trend lines supporting the current rally. Prices are approaching both. While momentum is dropping, the risking CMF is positive.

It's still way too early to get excited about the U.K.. We've only got a few months of data compared with a horrendous track record over the last three years. Also remember this is an economy that is providing a great example of why austerity is a bad idea.