Although starting 2006 with little ambition for the UK economy, a stronger-than-expected return to f...
Although starting 2006 with little ambition for the UK economy, a stronger-than-expected return to form has led one UK economist to review his position.
Andrew Wilson, group economist at Royal Bank of Scotland, says: "Spring brought a surprisingly positive batch of survey data that pushed up interest rate expectations in financial markets. The Purchasing Managers Index (PMI) also revealed strong activity in April for both the UK and Eurozone, while UK manufactures reported an intention to increase their labour force to meet increasing demand for the first time in over a year.
"UK factories are humming, by their own modest standards at least, and slowly reducing the economy's dependence on the consumer.
"The rebalancing is not on account of service sector weakness. In fact, the (non-retail) service sector began the second quarter with output at a two-year high. There is a close relationship between the PMI level and the voting behaviour of the Monetary Policy Committee (MPC) and the latest findings took us within a whisker of rate hike territory."
However, Wilson believes with the MPC poised and waiting for the data to justify a raise, the strengthening of the pound, and to a lesser extent the weakening of the equity markets, could produce a monetary tightening on prices before the MPC has the chance.
He adds: "The rise of sterling (up 8% against the dollar since the start of April) makes imports more competitive and UK exports less so. Those businesses geared to trade are hurt and growth is constrained, while inflation is reduced by the low price of imported goods. The longer this 'pounding' persists, together with the indirect impact of weaker equities (FTSE 100 down more than 7% in May), the less momentum there will be for interest rates to rise."
Meanwhile, Ashton Bradbury, head of UK mid and small-cap equities at Old Mutual Asset Managers (UK), believes the UK economy will continue to grow steadily this year, with little likelihood of any significant interest rate moves. He adds: "This stability, with reasonable valuations, suggests equities should remain fairly resilient, notwithstanding developments overseas."
However, he says Old Mutual has adopted a more defensive stance in response to recent global conditions, where global equities have remained volatile.
He explains: "We are modestly overweight oils and selectively overweight industrials which are late beneficiaries of an improving economic cycle and are still enjoying strong trading conditions. We are also overweight financials, where upgrades are likely, and support services, where there are some high quality, attractively valued companies."
One particular focus is social housing, according to Bradbury, which is benefiting as the Government outsources maintenance and refurbishment work. Against this, underweight areas include consumer-related sectors, where trading conditions remain difficult, food producers, which are experiencing pricing pressure, and transport, where valuations are expensive.
"The strong performance of mid caps over recent years means this area of the market is now rated at a useful premium to larger companies. This premium rating can be sustained, given continued benign economic and market conditions, but would be vulnerable should conditions deteriorate," Bradbury predicts. "We expect the near-term environment to remain difficult, but will look to add value through good stock selection, focusing on sensibly-priced companies that offer sound growth prospects."
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