UK recession: bump or slide?UKrecession:bumporslide?

Official figures released last week showed Britain’s economy fell into recession at the end of 2023. Contraction in the third and fourth quarters gives Rishi Sunak’s government – who promised to boost growth – plenty on which to ruminate. Yet today Andrew Bailey, Governor of the Bank of England, said the economy is already showing ‘distinct signs of an upturn’. So is the recession already over, or is worse in store? We asked our experts for their perspectives in this quick take.  

“At best we are looking at a small improvement in overall GDP growth for 2024 to something close to, but below 0.5%.” Katharine Neiss, Deputy Head of Global Economics and Chief European Economist – PGIM Fixed Income

UK GDP in Q4 of 2023 came in significantly worse than expected, contracting 0.3% on the quarter versus the expectation that activity would be broadly flat. The bad news didn’t stop there, with GDP in the first half of last year revised down, leaving growth for the year as a whole barely registering in positive territory at just 0.1%. The weakness is fairly broad based, but particularly in household spending. The good news is it could have been worse, and indeed that was the consensus view at the start of 2023. 

The labour market endures as a relative bright spot, with unemployment remaining low and job vacancies high. Real wages are growing again and should support consumption going forward. Some high frequency indicators - such as surveys of firms, confidence indicators and a rebound in retail sales in January - corroborate the view of an improvement. However, investors should not expect the UK to return to anything like the kinds of annual growth rates that we experienced  in the decade before the pandemic of between 1.5 to 3% per year.  

“News that the UK economy has entered a mild recession does little to dent our view that 2024 will represent the trough for the UK real estate investment market.” Greg Kane, Head of European Investment Research – PGIM Real Estate

One key area to watch is the impact on the UK rental housing market. As the effect of higher interest rates on households feeds through, difficulties in refinancing and challenging conditions for new buyers mean that many more households are set to move into the rental sector in the coming years, driving demand for affordable rental housing options. Limited supply is supporting the rental growth outlook.  

Investment yields still have a little further to adjust, but our view is that a trough in values in 2024 provides a platform for strong returns on investments in UK rental housing going into the next cycle.

“Technical recessions spawn rapid headlines but don’t have to generate poor market returns.” Stuart Jarvis, Managing Director, Institutional Advisory & Solutions – PGIM

Market prices act on a very different time horizon: they aggregate views of the future economy, they are not barometers of current activity. Markets therefore often do less well prior to a recession and then start to rise before the recession is over. It is changes in forecasts for the economy that see the most significant market return impact. Investors should avoid thinking about return histories as falling into two regimes (recessionary and growth periods); the inflection points - the moves from one to regime to another - are key. Our recent research on indicators that predict recessions showed that it’s the changes in these indicators that have the strongest implications for future returns. The challenge therefore is not to build a portfolio to weather a recession, but to have a strategy that is also positioned to benefit from the market upswing which is likely to occur before the recession is over.

That the fight against inflation in the UK has led to a hard landing shouldn’t be as surprising as the fact that the US seems to be avoiding a similar outcome. 

“This is the first real aftermath of significant base rate tightening for at least one generation of prime consumer…we are yet to see how this translates.” Matthew Harvey, Partner, Direct Lending – PGIM Private Capital

It remains to be seen how the base rate tightening we’re experiencing is yet to fully play out across various sectors already grappling with labour cost and supply inflation such as building materials, food and beverage and entertainment and hospitality. Managers should approach these opportunities cautiously, and while some general cyclical risk can be underwritten, more conservative, first lien structures for light industrial and business services issuers is preferred.