Market review April 2018: what’s next for UK interest rates, wages and sterling?

Andrew Milligan

With inflation starting to roll over, this month I consider whether the wage squeeze is finally coming to an end. I also take a closer look at how markets are responding to President Trump’s trade tariffs, hints from the Bank of England Governor that UK interest rates may not rise as quickly as expected and what the Brexit outlook might mean for sterling. Lastly I discuss how the ‘threat of the internet’ is affecting the UK high street and what Facebook’s data breach means for investors and the digital economy.

All quiet on the Trump trade front

Financial markets were quite shocked when President Trump started tweeting much more robustly on the topic of trade tariffs. But, like many of us, they’ve learned to adjust, helped by more moderate comments from other members of the White House administration.

Investors are well aware of the potential risks of a trade war – it’s the last thing the world economy needs! But they’re also aware that the President has a well-recognised negotiating style. He starts with a very strong proposal and uses a series of threats as a way to reach an outcome which is more satisfactory to him – or in this case to the US voters who support his views about ‘making America great again’.

Some moderate statements from Chinese, US and European officials have definitely taken the heat out of the situation in recent weeks. But as with any brush fire, it could burst into life again at a moment’s notice.

The wage squeeze is coming to a close

UK inflation fell back to 2.5% year-on-year in March, the first time it has rolled over since late 2013. This does suggest the wage squeeze is coming to an end – which will support consumer spending – but it will be a slow process.

Average weekly earnings have been creeping higher, rising about 2.75% from this time last year – showing that the UK actually does have a strong labour market, surprising as this might be to many people. For example, the current unemployment rate of 4.2% is the lowest since the 1970s – although of course we live in a very different world now with many more people on gig-type contracts and more self-employment.

For some time, inflation in the UK had been under upward pressure as a result of the decline in the pound after the Brexit vote. But those pressures are dissipating, and most estimates are that inflation will edge down steadily from 3% in January of this year towards 2% by the end of the year.

One thing to watch out for though is oil prices. They’ve started to edge higher, driven by political concerns as well as supply problems. That could feed through into petrol costs, and affect inflation and incomes. Our portfolios include the cruise operator Carnival, but we trimmed our positions when the oil price started to rebound as this is an increasing cost headwind for such companies.

Mark Carney surprises investors

The Bank of England’s Mark Carney has hinted that interest rates may not rise as quickly as expected. These comments initially did surprise investors – but they understood the context better after the weak economic report for the first quarter, hampered though it was by the appalling winter weather!

The market has become much less certain about the timing of the next move on interest rates, depending now on the speed with which the economy recovers into the summer. Sterling shows how quickly markets can respond to these changes in view: as high as 1.44 against the US dollar it fell to 1.36 after all that news.

A more positive Brexit outlook?

Investors are keen to know how much the currency is also being affected by Brexit. The short answer is – that depends on your timescales. In the short term, yes, sterling did rise against the US dollar. That was partly as investors took a more positive stance towards the UK/EU negotiations and partly because the UK economy looked a little stronger than expected. However, a mixture of reassessment of the outlook for interest rates and some negative headlines about problems with the Irish border have taken the gloss off the pound.

Looking ahead, we still warn that the pound could be rather volatile against the dollar and euro. And remember that volatility in the stock market affects overseas profits when they’re translated into pounds at better or worse exchange rates.

On top of the Irish border issue, there are complicated EU/UK talks on transition agreements which really should be completed by October, and then a mass of legislation which needs to be voted on in Brussels and Westminster by spring 2019. So there’s still a political and legislative mountain to climb. Our portfolios generally hold other currencies than sterling, ones where economic fundamentals rather than political uncertainties are more important as drivers.

More trouble for the UK high street

The UK high street continues to see some of its big names in big trouble. Of course, many consumers are cautious when it comes to spending, perhaps worried about their jobs and the wage squeeze. However, there are several other very important factors at play in the UK and other countries too. We might sum them up as ‘the threat from the internet’.

Online shopping is a way of life for many people, across a growing range of sectors. There have been some recent high-profile failures on the high street, such as Maplin and Toys R Us. Another aspect that’s affecting the shelf–life of high street shops is that many households are choosing to buy fewer goods and experience more activities. More people appear to have decided that they have enough ‘stuff’ and would rather spend their money on hotels, bars, restaurants, cruises or other leisure activities. Our UK portfolios include some of the winners, such as online retailer Boohoo.

Facebook’s fall from grace

Facebook’s data breach and Mark Zuckerburg’s congressional inquiry have dominated the headlines in recent weeks. And it looks more likely that the US will implement more stringent privacy laws, similar to the introduction of GDPR in the UK and Europe. But what does that mean for investors, tech companies and the digital economy?

Truth be told, it’s too soon to tell. Many people noted that the US Senate didn’t appear to understand social media very well when it held its inquiry with Mark Zuckerberg. So will any new legislation be well drafted?

It’s true the share price of Facebook did fall but it’s still up very robustly since the start of 2017. It will be important to look at the degree of regulation on a case-by-case basis. And while there are concerns about other aspects such as slower sales of smartphones from Apple and other major suppliers, the fact is the demand for other products and for cloud computing goes from strength to strength.

All in all, an investor will need to undertake some very deep research and be very stock-specific about what they include or exclude in a portfolio. We remain overweight in Alphabet, which includes Google.

The information in this blog should not be regarded as financial advice. Please remember that the value of your investment can go down as well as up and may be worth less than you paid in. Information is based on our understanding in May 2018.

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