Weekly Market Review – Third time unlucky

The UK economy has dipped again, prompting economists now to speculate about a ‘triple-dip’ recession. This would come next year, the arguments runs – potentially after a Greek exit from the euro – and would threaten the UK’s coveted AAA rating. Should investors be worried?

The second quarter’s 0.7% decline in GDP was far higher than the 0.2% fall that had been expected by economists. Although there were some obvious reasons behind the weakness – the extra holiday for the Queen’s Jubilee, the wet weather – it still suggests the economy is, at best, stagnating.

Certainly the news prompted plenty of hand-wringing about the state of the UK economy. The political debate centred around whether the Chancellor should now ease back on the austerity measures with the Labour party putting the blame squarely on the government’s fiscal squeeze. However, other commentators suggest the austerity measures have been insufficiently severe to act as a real drag on growth and the problems lie elsewhere – with business investment, with the banking sector and/or with a lack of consumer confidence.

The debate over what is to blame makes the search for a resolution trickier. The Olympics will certainly provide a short-term solution. Plenty of economists believe it will provide a compensatory boost for the economy in the second half of the year, possibly adding as much as 0.5% to GDP. However, it is unlikely to create the structural growth the economy really needs.

Central bankers are running out of options. There will almost certainly be more quantitative easing, though with an increasing recognition it is subject to diminishing returns. Policymakers are also now proposing to lower interest rates further, possibly to 0.25% or even zero. However, investors would be wise not to expect any immediate impact from a rate change. The cuts in rates are unlikely to filter down to consumers and corporates in full and there remains a real question mark over whether either sector really wants to borrow.

So should investors be abandoning risk markets? Perhaps the most important thing to note is that markets do not appear to care about the state of the UK economy. They remain more preoccupied with the machinations in the eurozone than any mild domestic troubles.

That is probably correct. No government-led solution is likely to turn round the UK’s fortunes substantially while a resolution to the crisis in the eurozone just might. Equally, the stockmarket is not the economy and, while corporates cannot resist the weakness of the economy permanently, for the time being they appear to be in good shape and lowly valued.

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