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Podcast transcript

Economic outlook podcast

Interviewer: Hello and welcome to this latest edition of Barclays Corporate insights. I'm joined again by Henk Potts our director of investment strategy at Barclays Private Bank. Hello Henk.

Henk Potts: Hi, nice to be with you again.

Interviewer: Now we're recording today just as the US president is arriving in the UK, for his state visit, so let's get straight to it and discuss some of the big stories about US trade policy.

Henk Potts: Yeah, we absolutely should. There's no doubt of course it's one of the driving forces if not the most important force in terms of market sentiment and businesses are watching it incredibly closely to see developments around policy coming through from the president. And of course particularly the impact that has in terms of trade wars. We've spoken in the past about why economists worry about trade wars. They reduce global volumes, they discourage businesses from investing, but most importantly they push up consumer and producer prices. Now the hope has been for some time, of course the economic pragmatism would prevail and the deal would eventually be done. It feels like we're moving further and further away from that hope, it has to be said. The president far from de-escalating tensions, if anything has been ramping them up. More recently we had that tariff bomb shell of course on Mexico a few days ago.

Henk Potts: The imposition of higher tariffs on Chinese exports, turning his attention away from governments to focus on individual companies, the weaponising of exports as it's been described. And of course there's the effect of the retaliatory action that you'd expect. And clearly that poses a problem in terms of growth profiles and in terms of business sentiment as well. So where do we go from here? Well, I think the reality is we have to live with higher tariffs for longer than was originally anticipated. The economic impact is likely to be more severe and widespread than originally projected. The potential for disruption for business models could be more significant as well, so we've been lowering our growth forecast for regions that are affected by that. That doesn't only mean China. Of course, China is the world's largest exporter. So inevitably it's been caught up on this and we think the imposition of the tariff on 10-25% will reduce Chinese growth.

Henk Potts: Maybe between 30 and 50 basis points. If President Trump does go ahead in terms of his threat to impose a 25% tariff on all the remaining exports into the United States, we think that will further reduce China's growth profile by half of 1% but also I think there is likely to be pressure on the United States as well in terms of its growth profile. Now it's been suggested maybe the US could be more immune than other countries from a trade war and that is probably the case. It's much bigger. It's a much more diversified, more insular economy. But in saying that weaker global growth means that there'll be less demand for US products and services. Businesses will have to pay higher input costs, consumers will have to pay more in terms of when they're buying goods and services and that's going to have an effect.

Henk Potts: So we've been lowering our growth forecast for the United States as well. We now expect the US economy to grow 2.5% during the course of this year compared to the 2.8% previous forecast. Perhaps a more pronounced slowdown as you look out to next year where we think growth from probably slow to something closer to 1.4% compared to our previous predictions before the escalation of the trade wars or somewhere closer to 2% so having effect there. But also having an effect probably around policy as well coming through from the Federal Reserve, the US Central Bank, we now expect them to put in place an insurance cut in an effort to try and maintain the growth profile so we could see significant movements over the course of the next few months when it comes to policy.

Interviewer: Okay. And some of the stuff that we've seen coming off the back of that, I was having a look at technology stocks in the US. During May they lost something like $500 billion of their, of their market value. Is that some of the real impact coming through or is that just sort of a short term, you know, market reaction to what's happening in the news cycle?

Henk Potts: Yeah, there are real impacts for specific sectors. Some sectors of course are seen as more vulnerable than others. Technology is certainly one of those, we know the Chinese markets an important growth area of some of the big technology majors in the United States. If you look at transportation, machinery is an incredibly important areas, another sector that seen as particularly vulnerable. Agriculture is also seen as vulnerable. So there's a range of areas that are gonna be hit pretty hard as we go through these trade disputes. And that's been certainly playing out in markets. But remember it's not just in the United States, it's not just China. Look at the European auto sector that's had a miserable May. Fell 14% over the course of the past month as investors worry about the potential impact coming through from the trade disputes. So what you're seeing is the tangible effects of these policies filtering through to business models and in turn of course, market sentiment.

Interviewer: Okay, let's move on. You know, you mentioned the European auto market there. Arguably one of the other things that might be buffeting that market is Brexit. Since our last episode was published, the March 29 date that was etched in stone for the UK departure from the European Union, that's gone.

Henk Potts: Crumbled away.

Interviewer: It was pushed back first to mid-April. Then again in an 11th hour summit of EU leaders back to the 31st of October, Halloween. Uh, lots of, lots of great jokes to be had there. You know, why is that date significant and what's the sort of the impact that that move back to Halloween has had for the UK?

Henk Potts: Well, it is significant of course in some ways it reduces some of the pressure in terms of a deal to be done, but also results in a broader range of potential options that could play out. And alongside that, of course you've got Theresa May's resignation as ramifications for the Brexit negotiations. Markets gearing themselves up for what could be a bitter leadership battle amongst the conservative contenders; it's a very long list, as we know of candidates. Front runners, very much seen as euro-sceptics - it's led investors to assign perhaps a higher probability of a no deal playing out. Finding a consensus in Westminster has always been a difficult task and there's some commentators suggest the political impasse is only ever going to be broken through a second referendum or indeed another general election. So we've got that bubbling away in the backdrop. I suppose the positive, is actually the UK economy in the meantime has been holding up pretty well.

Henk Potts: We had growth remember of half of 1% quarter on quarter in the first three months of the year, but somewhat artificial, you have to say. You feel that there's an element of stockpiling that was happening during the course of that period. The fact that deadline is moved out so dramatically has reduced some of that urgency so that momentum is likely to come out if you look to the data during the course of the second quarter and beyond, but the UK economy continues to benefit from low levels of unemployment. Unemployment as you know is at its lowest level since the early 1970s. Pay growth continues to be positive. You've seen credit gains coming through and the weaker currency is also helping demand as well. So there are some elements to be positive about, but the reality is you've still got the potential for an intensification of Brexit uncertainty filtering through to household consumption and particularly business investment that we think will continue to weigh on the UK growth profile during the course of this year. So we expect growth somewhere close around 1.2% this year. Not a disaster, but certainly below its potential.

Interviewer: Yeah, it's interesting isn't it? There seems to be some sort of inherent contradictions in the UK economy at the moment that you, like you said, unemployment at pretty much record lows, employment rate at record highs over 76%. But then on the other hand, you know, we had the manufacturers purchasing managing index came out today. That's negative for the first time in awhile and there seems to be that uncertainty just creeping in again to the data.

Henk Potts: Yeah, I think that's right. Particularly the forward looking indicators, are suggesting that it's a more fragile backdrop. Some of the backward looking data points that we have been seeing and potentially we'll start to see that shine through in terms of the numbers. In some ways you feel that businesses have almost given up on trying to predict where Brexit is likely to go and move to a more wait and see mode, perhaps business as usual. But eventually what you start to find is of course the lack of commitment. So those longer term investment plans beyond that business as usual, we'll indeed weigh on the UK's growth options.

Interviewer: Now we had the EU parliamentary elections of course, voters here in the UK never expected to vote in those elections, but they're done. The Brexit party was of course the big headline here in the UK, but across Europe it was a bit of a mixed picture. Overall those traditional center right center left parties and the Liberals and the Greens, those pro-European parties have seemed to to win a majority. The sort of far right surge that many were predicting never, never really came through. So, uh, you know, as we look forward in the eurozone, there's a new president of the European Central Bank due to come in, as I say, towards the end of October. What does all this, the picture look like in Europe now?

Henk Potts: Well, it's a fragmented result, there's no doubt that from the European elections, I think from a market perspective it'll take some time to play out. In terms of areas that we'll be focusing on, there'll be the renewed budget battle of course between the European Union, between Italy. Ramifications in terms of Brexit negotiations that we've been talking about, but also trade negotiations so far you think about trade negotiations specifically between China more recently Mexico and the United States. A big deal has to be done with Europe as we head through the summer and into October and that will be seen as an important milestone as well. As you say, the allocation of some of the top jobs will be important in terms of policy for markets. European Central Bank is obviously going to be top of that list. I think more broadly when you look at Europe, clearly it's been a disappointment over the course of the past 12 to 18 months we've seen weaker external demand, and the impact of slowing global growth and the trade wars.

Henk Potts: Of course, lots of internal disruption. Yellow vest protests taking place in France. The problems that we've seen in the German manufacturing sector, particularly the auto industry's, gone through a very tough time and of course as I say, that budget battle infringing upon corporate confidence in Italy, discouraging businesses from investing and also from hiring as well. In terms of the positives, I think you'll start to see a stabilisation in terms of activity and sentiment as we go through the rest of this year helped by the fact that unemployment has been falling. Eurozone unemployment falls at a slower rate than you'd expect to see in the United States, given all the protections that have been put in place, but eurozone unemployment is the lowest that we've seen in a decade. Pay growth isn't fantastic, but still running comfortably higher than we've been seeing. Inflation, of course, fiscal stimulus I think will be an important element of support as we see the bigger economies introducing probably the most fiscal support that we've seen probably for a decade. Alongside that, the European Central Bank in the process of launching another targeted longterm refinancing operation that will be aimed at improving liquidity, encouraging banks to lend more money, keeping borrowing costs down. And that should lead as I say a more stable environment within the eurozone. You can imagine growth during the course of this year still managing somewhere close to 1.3% picking up slightly as you look out to next year, maybe growth, getting back to 1.4%. Again, not a fantastic performance, but again, not perhaps the recession that some economists have been suggesting is likely to be the case.

Interviewer: Now it seems if you open up a newspaper, the UK high street has been sort of fairly heavily buffeted by the winds of change recently. Now what's driving this? Do you think are the fundamentals of consumer spending staying strong? Is that, are we just seeing a shift towards different channels, online channels perhaps?

Henk Potts: Inevitably, there's been a real change in terms of retailing in the UK. We should've expected that. It's probably more advanced than we've been seeing in economies elsewhere. We know it's been a really tough time for the high street along with changes in terms of technology. They've also had to deal with higher rates, of course, higher labour costs, utility bills have been rising and that's made it very difficult for them to compete alongside some of their new online competition. I think in general terms spending has been holding up better than anticipated with some of the reasons that we've already talked about. Unemployment continues to be very low, pay growth continues to be positive, so the backdrop still remains relatively good. You have to look at the savings ratio that has been low it has to be said, and that has been supporting growth. Eventually consumers I think will become less confident, may feel they have to save a little bit more money and you'll start to see that reflected in the amount they're prepared to spend in shops.

Henk Potts: But so far I think spending has been holding up, but it's moving into those different areas and reality is if you want to compete for the consumer's pound, then you've got to have a range of factors in place that again, that we've mentioned a number of times where they include strong online proposition, great delivery channels, great service channels, being incredibly competitive in terms of price. Remember there's a huge amount of transparency out there for consumers and the reality is that means they can go out and get the best deals. If you're not offering those, then you're going to miss out on some of that important business. But that has the effect of course, of very much squeezing some of the margins that we've been seeing.

Interviewer: Okay, so the fundamentals in the British economy and to a degree, the global economy, although storm clouds brewing are good. Is there anything in particular that we haven't mentioned that businesses need to be watching out for?

Henk Potts: Listen, it feels like we've gone through a huge amount of turmoil over the course of the past few months. Been a lot for businesses to have to deal with: trade wars, the implications for global growth alongside that we've been seeing concerns around the political and social environment within the eurozone. Seen pressure on emerging markets, that's come from a range of different areas including country specific issues. Slowdown that we've seen taking place in China and the stronger US dollar. Brexit continues to be somewhat disruptive. I don't think we need to be too pessimistic about the prospects for the global economy or indeed the UK economy. For us, what we've been seeing is moderating but still reasonably robust growth over the course of the next couple of years. We continue to see the economic cycle continuing. We expect growth somewhere around 3.4% during the course of this year. Again, not amazing, but not a disaster. The next recession still looks in the distant horizon for us. So yes, we are inevitably talking about the late cycle. We're coming to an end of a very long period of growth, but that late cycle can still last a couple of years, and that means there's still plenty of opportunities, I think, for businesses to flourish.

Interviewer: As always, Henk it's a real pleasure to hear from you. Thank you for your time.

Henk Potts: Good to be with you.

Interviewer: That's all from Barclays corporate insights. Make sure to follow us @BarclaysCorp on Twitter and Barclays Corporate Banking on Linkedin. Until next time, goodbye.

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