UK Economic Update – 05 September 2014

UK industry activity continues to build momentum, external demand slips in August

The opening to September saw yet another mixed bag of PMI surveys released for the Services, Manufacturing and Construction sectors. In detail, both services and construction industries outperformed against expectations, with both reaching close to or above new highs for 2014.

This was while the pace of activity in the Manufacturing industry slowed for the second consecutive month.

In addition to the lower PMI, there were also indications from data providers that prices of manufactured goods fell once more during the month, which makes for the third period of such weakness and bodes ill for any interest rate hawks hoping that rising inflation will spur the Bank of England into action.

All in all, the week’s data suggests that the internal recovery within the UK remains strong, with domestic demand across all three key sectors increasing rapidly over the course of August. However, lower export orders from overseas partners and weaker pricing led the manufacturing PMI to decline further during the month.

While in previous periods it would have been tempting to link this decline to the strength of sterling, there is evidence to suggest that there were other drivers of lower orders and activity during the month. Most notably, comments from Markit economists suggest that demand from North American and Asian markets remained strong during the period, while orders from Europe fell substantially.

Consequently, we conclude that the reduction in external demand came as a result of a weakening in the eurozone economies and higher levels of uncertainty stemming from geopolitical conflicts; not a broad based slowdown in international markets or because of currency linked effects.  

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Scottish referendum

Going forward, risks exist to economic sentiment and output in the UK given the looming Scottish referendum which is due to take place in mid September.

Should the Scottish people vote for independence on the 18th then the UK economy could enter a period of uncertainty where economic activity slows by some measure.

Equally, and on the same note, should the margin with which the Scottish people vote to remain part of the Union be only fractional; then the same aforementioned period uncertainty could still prevail over the economy.

A clear and resounding “no” to independence from the Scottish people would be the only way to prevent another similar vote at a later date, that could once again disrupt the economy.

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Geopolitical risks

In addition to risks emanating from the threat to political union, the UK and many other economies are also exposed to rising levels of geopolitical risks. With a diplomatic resolution to the Ukraine crisis yet to be found and given that NATO leaders have now begun to prepare plans for the deployment of military forces to eastern Europe; the current crisis in international relations between Russia and the west is becoming more and more difficult to avoid.

So far financial markets have continued to shrug off the developing crisis, barring the odd bout of news reactive volatility, although protracted period of time without resolution could threaten the prevailing sense of indifference.    

While a Moscow endorsed ceasefire has, at the time of writing, led to a break in the conflict; it is not clear that this will be enough for the international community to stem the flow of sanctions against Russia.

Equally it is also unclear what the reaction from Moscow will be to a further round of sanctions in the face of the ceasefire, or to the positioning of western military supplies in eastern Europe.

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The takeaway

Risks facing investors have increased substantially throughout recent quarters. While growth in the developed world has been above trend and looks set to continue in this way for a period of time at least; equity markets also remain at or close to all time highs.

With the monetary policy environment for developed markets evolving, amidst no shortage of risks that threaten to dent both confidence and potentially future output; we are becoming increasingly unsure as to whether or not the potential gains on offer from this point are sufficient enough to justify the risk accepted ongoing high allocations to risk assets such as equities and lower rated bonds.

Consequently, we will continue to assess both new opportunity, as well as our existing portfolio holdings, with increased levels of caution throughout the weeks and months ahead.

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