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Analysis

UK’s poor GDP performance rooted in weak household spending

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The UK’s weakness in international economic league tables during the coronavirus crisis reflects stretched household finances and potentially wasteful public spending, according to a Financial Times analysis.

Britain’s poor economic performance relative to other countries is partly explained by differences between nations in the measurement of inflation, notably in relation to the health sector, which should disappear over time.

But the UK’s performance is also rooted in weak household spending and the government’s willingness to fight Covid-19 with an open cheque book, based on an FT analysis of the national accounts of countries that have published comparable data.

The findings will add to concerns expressed by MPs last week that the Treasury lost control of public spending amid the scramble in the first wave of the virus to establish a test and trace programme and buy personal protective equipment for health workers.

Official figures last week showed that UK gross domestic product in the third quarter in real terms was 9.7 per cent below the pre-pandemic level in the final three months of 2019: a figure more than twice as bad as comparable countries and only rivalled by Spain.

Bar chart of % change in GDP since Q4 2019 showing The UK economy has performed poorly during the pandemic after adjusting for inflation, but not in cash terms

But the GDP comparison does not look nearly as bad for the UK in nominal terms: before measured levels of national output or expenditure are adjusted for inflation.

This difference led some economists to warn that comparisons putting the UK at the bottom of international league tables were seriously flawed.

Kallum Pickering, economist at Berenberg Bank, said “beware the statistical oddities”.

He added that the UK’s data for the consumption of public services was adjusted for inflation in a different way to other countries, and until the pandemic was over “nominal comparisons may provide a better guide”.

There is no doubt that the Office for National Statistics has taken a purist’s view of the measurement of public sector output ever since a review in 2005.

The UK statistical agency separately counts the number of hospital operations and other NHS outputs, and then the money spent, and compares the two to arrive at its estimate of inflation.

During the pandemic, this method showed output down as non-urgent operations were cancelled, although the money spent by government was considerably higher.

This reflected how big spending increases on the NHS were agreed by ministers before the crisis, and the government allocated emergency funding to prevent the health service failing during the pandemic.

ONS figures suggest that the implicit inflation rate since the fourth quarter of 2019 in the health sector has been 91.4 per cent, meaning that the cost of treating people in the UK has almost doubled.

Officials at ONS believe their measurement practices are world leading, with one saying it was doing “a semi-decent job with limited data”.

Bar chart of Implicit price change since Q4 2019 (%) showing Inflation has been extreme in parts of the UK public sector

If this was the only difference between the UK and other countries, Britain could expect a higher economic growth rate than elsewhere in the future as the public sector returns to normal once the virus wanes.

But some economists said they saw other reasons for concern about the UK in detailed international comparisons.

Samuel Tombs, economist at Pantheon Macroeconomics, said the UK’s poor economic performance could not simply be attributed to different statistical methods because household consumption was weak compared with other countries.

“The vast bulk of the underperformance can be attributed to continued weakness in household spending,” he said, noting that UK private consumption was far lower compared with the pre-pandemic peak than that in other countries whether measured in real or nominal terms.

Bar chart of % change since Q4 2019 showing UK declines in household spending are higher than in other countries

“Persistent fears about contracting Covid-19, which remained more widespread than in most other European countries in Q3, likely are to blame,” added Mr Tombs.

FT analysis showed that with UK retail sales remaining strong through the pandemic, the weakness in household spending stems from lacklustre consumption of services. Britons notably have eschewed foreign holidays more than their counterparts in other countries.

With UK household consumption weak compared with other countries, it raises the question of which component parts of British GDP are stronger than other nations so that the overall nominal change in national income is similar.

The answer is that UK public consumption, the money spent by government on goods and services, has been growing much faster in cash terms than in other countries.

While nominal UK public consumption rose 15.6 per cent in the third quarter compared with the final three months of 2019, it increased just 3.5 per cent in Spain, 0.7 per cent in France and fell 0.1 per cent in the US.

None of these countries have had notably worse outcomes in the health sector than the UK during the pandemic.

The huge surge in UK public spending has raised concern among MPs and former government officials.

Nick Macpherson, former top civil servant at the Treasury, said there were signs of a lack of professionalism in government procurement, adding that “value for money is essential”.

Bar chart of Change since Q4 2019 (%) showing The UK is the only country to have seen a massive increase in public consumption in cash terms

But Tom Scholar, Treasury permanent secretary, rejected suggestions by MPs last week that the department had lost control of public spending.

“We’ve got exactly the same grip on spending that we would normally have,” he told the House of Commons Treasury select committee.

Sir Tom said the health department had needed to make “very quick decisions” on the sourcing of PPE.

“We agreed with them a larger delegated budget with high delegated spending limits to enable them to do that quickly, but that was a deliberate decision taken in light of those circumstances of extreme urgency,” he added.





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Analysis

UK pushes floating wind farms in drive to meet climate targets

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In waters 15km south-east of Aberdeen, renewable energy companies are preparing to celebrate yet another landmark in the drive to end Britain’s reliance on fossil fuels.

Five wind turbines, each taller than the Gherkin building in the City of London, fixed to 3,000-tonne buoyant platforms have been towed to the UK North Sea from Rotterdam where they will form part of the Kincardine array, the world’s biggest “floating” offshore wind farm.

Wind farm developers have dabbled since the 2000s with floating technology to overcome the limitations of conventional offshore turbines. These are mounted on structures fixed to the seabed and are difficult to install beyond depths of 60m, which makes them unsuitable for waters further from shore where wind speeds are higher.

Floating projects, which are anchored to the seabed by mooring lines, are rapidly moving from the fringes to the mainstream as countries turn to the technology to help meet challenging climate targets.

Britain was the first country to install a floating offshore wind farm off the coast of Peterhead, Scotland in 2017. But existing floating projects are modest in size. The Kincardine array has an electricity generation capacity of 50MW compared to 3.6GW for the world’s largest conventional offshore wind farm.

Map showing the location of Kincardine offshore floating wind farm, offshore from Aberdeen on Scotland's east coast

Now the bigger wind developers are stepping up a gear with plans to build more schemes on a larger scale.

Denmark’s Orsted, Germany’s RWE, Norway’s Equinor along with the UK’s ScottishPower and Royal Dutch Shell are some of companies on a long list of bidders vying to build floating schemes in an auction of seabed rights for about 10GW of offshore wind projects in Scottish waters. The bidding round closed in mid-July with the winners expected to be announced in early 2022.

The UK is separately examining an auction exclusively for floating wind in the Celtic Sea, the area of the Atlantic Ocean west of the Bristol Channel and the approaches to the English Channel and south of the Republic of Ireland.

Developers expect the costs of floating projects to fall rapidly as more projects are deployed. In 2018 floating wind costs were estimated at more than €200 per megawatt hour, nearly double the cost of nuclear power in the UK.

The Offshore Renewable Energy Catapult, a UK technology and research centre, is hopeful developers will be able to build “subsidy free” floating projects at prices below forecast wholesale electricity costs in auctions as early as 2029. Conventional offshore wind developers reached this inflection point in a UK government auction in 2019.

A Norwegian flag flies from a boat near the assembly site of offshore floating wind turbines in the Hywind pilot park, operated by Equinor
Norway’s Equinor is among the companies competing to build floating turbines in Scottish waters © Carina Johansen/Bloomberg

UK prime minister Boris Johnson, who is hosting the UN’s COP26 climate summit later this year, has set a 1GW floating target out of a total 40GW offshore wind goal by 2030. He has underlined the importance of accessing the “windiest parts of our seas” as part of the UK’s goal to cut carbon emissions to net zero by 2050. 

Other countries including France, Norway, Spain, the US and Japan are pursuing the technology, which experts said would particularly appeal to countries with limited access to shallow waters, or where the geology of the seabed makes it impossible to install conventional “fixed-bottom” turbines.

WindEurope, an industry body, predicts one-third of all offshore wind turbines installed in Europe by 2050 could be floating.

Countries pursuing floating wind are interested in it “not just as an opportunity to deliver net-zero targets. It has a real potential to be a driver of economic growth as well,” said Ralph Torr, a programme manager at the Offshore Renewable Energy Catapult.

Much like how the UK supply chain has lost out to foreign companies in the construction of conventional wind offshore farms — despite Britain having more than anywhere else in the world — there are concerns the mistakes will be repeated for floating technology. Manufacturing work for the Kincardine project was carried out in Spain and Portugal and the turbines and foundations assembled in Rotterdam.

An offshore wind turbine off the coast of Fukushima, Japan
A wind turbine off the coast of the town of Naraha in Japan’s Fukushima prefecture. Japan is one of the countries pursuing floating technology © Yoshikazu Tsuno/AFP/Getty Images

Competition with other markets was already high as they all tried to gain a “first-mover advantage”, said Torr, who warned the UK government’s 1GW floating wind target by 2030 was not “going to unlock huge investment in the supply chain or infrastructure because it’s [just] a handful of projects”.

The Offshore Renewable Energy Catapult and developers are urging the government to commit to a second target in 2040 for floating wind, which they believe would provide confidence to industry to invest in the necessary facilities in Britain.

“Because floating [wind] becomes economic in the 2030s, it’d be much better to understand what the longer term pipeline is,” said Tom Glover, UK country chair at RWE. He added that in the Scottish seabed rights auction, developers had to “provide a commitment and an ambition for Scottish content”, which should benefit the local supply chain.

Wind developers are conscious that UK suppliers need time to gear up. Christoph Harwood, director of policy and strategy at Simply Blue Energy, which is developing a 96MW floating scheme off the coast of Pembroke in Wales, said projects that were larger than the earliest floating schemes but were not yet at a full commercial scale would be important in that process.

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“If the UK supply chain is to benefit from floating wind, don’t rush into 1GW projects, take some stepping stones towards them,” he said.

Tim Cornelius, chief executive of the Global Energy Group, which carries out offshore wind assembly work at the Port of Nigg on the Cromarty Firth in north-east Scotland, said the size of floating wind turbines offered opportunities to UK suppliers. 

The floating turbines are much bigger than their conventional offshore counterparts so need to be built closer to their point of installation, which precludes using the lowest cost manufacturers in China and the Middle East.

The floating turbines require “an astonishing amount” of deepwater quayside space at ports, Cornelius explained. His company is looking at creating an artificial island for quaysides in the Cromarty Firth in Scotland, which he says would require a “material investment but is entirely justifiable as long as developers are prepared to commit”.

But he warned that “as it currently stands, the [UK] supply chain isn’t in a position to be able to support the aspirations of the [floating offshore wind] industry”.

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Analysis

China tech crackdown claims ETF victims

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Exchange traded funds updates

Beijing’s regulatory crackdown on some of its biggest companies in technology and education has delivered a bruising blow to highly specialised China-focused exchange traded funds.

Broad-based tech ETFs have sailed through virtually unscathed, but some narrowly focused thematic instruments have taken a beating. Among those most affected, the KraneShares CSI China Internet ETF (KWEB) has nearly halved in value since its peak in February.

Some ETF buyers are hunting specifically for targeted strategies, despite the risks. But Kenneth Lamont, senior fund analyst at Morningstar, said this highlights the potential drawbacks of tracking a narrow theme without the flexibility to shift tactics.

“The [passive thematic] strategy has no way to quickly react to bad news and will hold the stock until the next rebalance. The small number of fund holdings also means that overall returns can be influenced by the performance of handful of stocks,” Lamont said.

Line chart of Total returns, year to date (rebased) showing Narrow vs broad tech ETF

He noted that for the KraneShares ETF, one Chinese education group alone — TAL Education Group — was responsible for knocking 2.8 percentage points off performance from the end of June.

Global X Education ETF (EDUT), which has a large exposure to the Chinese online education sector, was also badly affected.

Actively managed ETFs, such as Ark Invest’s ARKK flagship Innovation fund, can react more quickly. After voicing her optimism for the prospects for China’s tech disrupters earlier this year, Cathie Wood, Ark’s chief executive, shed millions of dollars worth of shares in four China-domiciled companies.

Line chart of Number of shares held (millions) showing ARKK has been selling Chinese technology holdings

Investors in ARKK have not been rewarded as well as those who simply put their money in broadest based funds such as the Vanguard Total World Stock Index Fund ETF (VT), but they have still managed to ride out the China tech storm far better than more exposed counterparts.

Line chart of Returns, year to date (rebased) showing ARKK vs Vanguard Total World Stock ETF (VT)

Some investors insist Chinese investments can bounce back. Mark Martyrossian, chief executive of UK-based Aubrey Capital Management, said he believed many of the affected tech companies would maintain their market leadership.

“The gravy train may have slowed but you disembark at your peril,’ Martyrossian said.

Lamont said badly hit funds had suffered such losses because they were doing exactly what they had promised to do — provide narrow exposure.

More nimble active investment strategies also face their own challenges, said Elisabeth Kashner, director of global fund analytics at FactSet. “Active managers may successfully anticipate market reversals, but they can also miss them, sometimes seriously tanking returns,” she said. “Some people can be skilful and some people can be lucky and if you’re lucky and skilful in one period you might be lucky and skilful in the next, but you might not.”

Additional reporting by Steve Johnson

Click here to visit the ETF Hub



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Analysis

Raisi vows to restore ‘trust’ with disillusioned Iranian public

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Iran’s new president Ebrahim Raisi will assume power this week at a time of huge challenges for the Islamic republic, shaken by recent protests over water and electricity shortages and readying itself for more talks over the revival of its nuclear deal with global powers.

Raisi, a 60-year-old veteran of hardline politics and mooted as a successor to the supreme leader Ayatollah Ali Khamenei, secured victory in June on the lowest turnout in any presidential election since the 1979 theocratic revolution and only after barring his most serious rivals from the race.

After the election he acknowledged that “public trust has been marred” in the country’s political elite, though he suggested the outgoing centrist president Hassan Rouhani was to blame for this disillusionment. Rouhani signed the 2015 nuclear deal with the US and other major powers, only for the then US president Donald Trump to abandon it in 2018 and sanctions to be reimposed.

This waning trust could be “repaired”, Raisi said, by focusing on the home front rather than looking for foreign assistance. “Reforming the current situation is possible,” he said.

However, the new president could find himself immediately facing a fresh international row after Israel on Sunday accused Tehran of involvement in Thursday night’s suspected drone attack on an oil tanker off the coast of Oman, in which two crew members were killed. The vessel, the Mercer Street, is linked to an Israeli billionaire. The UK foreign secretary Dominic Raab said on Sunday it was “highly likely” Iran carried out the attack in “a clear violation of international law”. Iran denied any involvement.

And with Iran in the grip of the worst drought in decades and power shortages hitting an economy already ravaged by inflation, sanctions and the coronavirus pandemic, analysts are sceptical that a quick turnround is possible. Only 3 per cent of Iranians have been fully vaccinated against Covid-19.

“The country is in a very tense situation and Raisi has to make very quick and serious decisions about urgent issues such as inflation and vaccination to present a winning card and buy time until a big decision is made about the nuclear deal and sanctions,” said Saeed Laylaz, an analyst.

“But we have not yet seen any initiative from Raisi since his victory to suggest he will be able to pin something big down during his first 100 days.”

Vienna talks

One of his biggest challenges will not be in Iran, but Vienna, where talks about the nuclear deal are set to resume when the Raisi government takes office. Tehran is in talks with world powers, with the US indirectly involved.

Raisi has made clear he wants to improve relations with neighbours, rather than the western world. “In order to help establish sustainable security and regional stability, the solution is co-operation between regional states based on mutual trust and not allowing interference of alien [western] forces in the region,” he said.

Hardliners have so far refused to make any promises about the outcome of the talks, preferring instead to focus on domestic priorities. One of these politicians, Hamid-Reza Taraghi, has listed the new government’s top priorities as curbing an inflation of 44.2 per cent, removing obstacles to domestic industrial production, dealing with water and electricity shortages and tackling the budget deficit.

But reformist analysts question how Raisi can do this while sanctions prohibiting oil exports and other business dealings remain in place. Taraghi has said the government had to find ways to “foil sanctions”, indicating that an agreement might not be reached.

Protests

One of Raisi’s most immediate challenges is to calm tensions in the southwestern province of Khuzestan, home to Iran’s biggest oil and gas reserves.

Recent protests have been driven by demand for water supply for farmlands and cattle. Raisi, allegedly part of a committee that executed thousands of political dissidents in the 1980s, has not been targeted by the protesters.

Still, demonstrators have chanted anti-regime slogans, such as “Down with the dictator” and “Neither Gaza, nor Lebanon; my life for Iran.” A regime that swept to power through street protests has typically cracked down on demonstrations. At least eight people have been killed in Khuzestan so far, Amnesty International said. Officials have confirmed three civilian deaths and one policeman. There have also been solidarity protests in the northwestern city of Tabriz, and protests over electricity shortages in Tehran.

Shopkeeper in Tehran
A shopkeeper in Tehran studies his phone after electricity is cut off due to energy savings by the government © Morteza Nikoubazl/NurPhoto via Getty Images

The regime has tried to boost water supplies to Khuzestan and Raisi has vowed not to “wait even one day” to tackle problems there. He said part of the “massive wealth” in that region had to be spent on its own development. He has also spoken of the economic pressures many people are under, promising to help build at least 1m new houses a year. “Today, not only buying houses but renting them in big cities or even small towns has turned into an unachievable dream for people,” he said in July.

Conciliatory moves

For now, the Islamic republic is determined to demonstrate stability through a peaceful transition of power. Raisi has met outgoing cabinet members individually and approached a wide range of politicians, including former political prisoners, about how the country should be run. Some of those arrested during the 2019 unrest, which allegedly resulted in hundreds of deaths, are set to be released, activists say.

Raisi must also contend with divisions in the hardline camp. The more radical members do not want him to bow to public demands for more social and political freedom. Parliament has ratified a plan that could regulate social media and restrict public access to the internet.

Iranians want to see if he can deliver on his promises. “Raisi has to spend 1 per cent of Khuzestan’s wealth for the province itself. This is not too much to ask and we will hold him accountable even though we have lost hope in any change under this regime,” said a protester in the province who asked not to be named.

The Khuzestan protester added: “I am 25 years old, hold an electronic engineering degree but have no job, no income and no future. The bare-feet people would not be scared of dying if their choice was between starving to death or being killed by bullets.”



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