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UK services showing signs of economic strain

Thursday, 4th April 2019 14:00 - by Shant

Earlier this week we received the final component of the triumvirate of PMI readings, the most notable of which is the services sector which accounts for over 70% of industry in the UK.  Whilst the surveys record the intentions of purchasing managers in terms of capital investment (human and financial), they do not fully reflect or predict the full extent of the potential outlook. 

 

Even so, the report does give an insight into the current landscape and some of the notable takeaways from the report included the lack of new (work) orders to replace completed projects, largely as a function of delayed decisions due to the Brexit impasse within the UK parliament.  Household spending has also suffered at the hands of this uncertainty, and as I have mentioned previously, investors should take note of the slow drag on output from a painful continuation of the Brexit process, which has now passed the point of frustration and has descended into a farce. 

 

At this point, I reflect back on my assumption that the UK and EU together would have recognised the damaging effects of a no deal outcome and would have collaborated to bring this sorry saga to a conclusion.  Such is the nature of assumptions - especially in this day and age - that one must account for any possibility, and it is somewhat of a conundrum that within this backdrop, we are in an exceptionally low volatility environment.  Needless to say, macroeconomic developments will eventually play out, and with services in focus, we can see that weakness is creeping into this sector, with the added fear that financial services will be vulnerable in the next round of trade negotiations - assuming (!) we ever get to that stage!

 

Putting the deterioration in new orders into context, IHS/Markit reported the latest series of falling sales as the longest since early 2009.  Export demand was particularly weak, underlining the broad-based impact of the global slowdown which has led major central banks to turn dovish in near unison.  The BoE is clearly sitting on its hands in the meantime, and until they get some form of clarity on the Brexit process, base rates will remain at current levels, looking at a possible 25bp hike should the UK and EU find a compromise.  This will, however, depend on a continued rise in wage growth, which up to this point has been presumed to be on the basis of resilience in the services sector.  On this point, the PMI survey notes that shortages of labour have restricted hiring plans, and as a result of attracting the best of talent, higher remuneration packages have to be offered as a result.  This could have an adverse impact on productivity going forward - at the very least from higher operating costs.  

 

So as I have cautioned in the past, service providers face a number of headwinds, which based on the long drawn Brexit process show little signs of abating over the medium term.  As mentioned above, the UK has yet to enter in to the future trade negotiations, and based on precedent, will take a number of years to conclude.  Given that access to the single market will likely impact on financial services to a larger degree, UK banks are likely to continue with their struggle in the current low rate environment, with the topical issue of branch closures around the UK a worrying sign that cost cutting is one of the key measures being used to bolster profitability.   Lloyds bank was a notable underperformer on the day, shedding 2%, as its retail banking focus leaves significantly more fragile as low rates test margins.  

 

Insurance companies with heavy exposure to domestic markets are also vulnerable as we saw with the collapse of Saga shares earlier this week.  Margins are getting squeezed among insurance providers and forced migration due to Brexit uncertainty will naturally exacerbate this dynamic in absolute terms as competition grows.  Direct Line followed suit today slicing over 5% off its share price over fears for the industry as a whole.  Prudential also lost ground today but by a more modest 0.6% or so.  Admiral was in positive territory however given its heavy reliance on motor insurance, which is mandatory rather than discretionary. 

 

So from the above, we can only deduce that disposable incomes are vulnerable at present, and the UK government would do well to read past the headlines of some of the historic data on offer.  Prolonging the Brexit uncertainty may allay imminent fears of a no deal withdrawal from the EU - but at what cost.

 

 

 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.

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