Sluggish Growth, Weak Government, Make UK a Tough Call for Investors

Above-target inflation, low and slowing growth, a fracturing property market and an unstable coalition government have propelled Britain to the status of 'Sick Man of the Investment World'.

Data coming out of the world's largest economies are largely surprising to the upside. China reported real gross domestic product in the second quarter of 6.9%, topping estimates, while South Korea's central bank revised its 2017 growth forecast for the continent's fourth-largest economy to 2.8% from an April projection of 2.6%, news outlets reported.

By contrast, the second-quarter UK GDP grew by a sluggish 0.3%. Moreover, while inflation is generally missing around the globe, in Europe's second-largest economy prices climbed 2.9% in August, tying the highest rate in more than five years.

Prime Minister Theresa May’s “reckless” Brexit plans pose a threat to millions of pounds worth of investment in schools and hospitals across the UK, Sir Vince Cable, the newly elected leader of the party, Liberal Democrat, said Friday.

An analysis by the party claims the European Investment Bank has provided £380 million ($516.1 million) in investment to schools and £345 million in hospitals since 2015–a vital source of cheap loans for “cash-strapped” local authorities, the BBC said.

The bank, which is the biggest multilateral borrower and lender in the world, has in total funded £31.3 billion of infrastructure spending, entrepreneurship and development in Britain over the past five years. But now the prime minister was “recklessly gambling with investment” in vital public services, he said.

This is especially important at a time when local authorities are short of money and public services are struggling to cope with increasing demand. “Theresa May is recklessly gambling with future investments through her extreme Brexit plans.”

Carney, May Hamstrung

With inflation rising and above target, the Bank of England would normally be considering rate hikes, but with Brexit looming and growth slowing, monetary tightening risks are stopping growth in its tracks. To stimulate growth, BoE Governor Mark Carney would instinctively want to be accommodative. However, any monetary loosening would likely spur inflation and a further weakening of domestic purchasing power. The BoE, in short, is hamstrung, Seeking Alpha reported.

In other parts of the world, the absence of inflation means central bankers can continue with monetary stimulus. The Bank of Japan has said it will buy as much 10-year government debt as it can find, sending yields to near its 0% target as investors realize they have an insatiable buyer. The European Central Bank has yet to trim its $60 billion a month bond buying program, while the Federal Reserve is maintaining a data-dependent stance on further hikes as inflation remains benign.

Back in the UK, it's not just Carney who is hamstrung. An inability to provide further monetary help is compounded by the likelihood that Prime Minister Theresa May will struggle to win support to backstop the economy with fiscal stimulus. May has little political capital after her gamble to call an early election in June backfired spectacularly, wiping out the Conservative Party's majority and forcing her into a minority government with the ultra-conservative Democratic Unionist Party of Northern Ireland.

As a result, the UK's Brexit negotiating position with the European Union is also severely weakened.

Moving Workers Out of London

Against this backdrop, cracks are showing in the real economy. The property market is sluggish while Bank of America Corp. and JPMorgan Chase & Co. plan to shift employees from London to Dublin as a consequence of EU Divorce.

Barclays Plc, BNP Paribas SA, Citigroup, Inc., Deutsche Bank AG, Goldman Sachs Group, Inc., Morgan Stanley and UBS Group AG are among financial institutions considering moving workers out of the British capital due to Brexit, which could create a surfeit of commercial space in the city and in London's secondary financial district, Canary Wharf.

So on both a relative and an absolute basis, there is little incentive to allocate capital to Britain—especially to companies with a primarily domestic focus—because there is little policy latitude to offset the deteriorating economy.

And until the geopolitical and economic risks change materially for the better, that's the way it will stay.