Why the UK Is Safe Haven Despite Poor Performance

The UK economy is experiencing what can best be described as a somewhat schizophrenic period that may last until the end of the year but will ultimately calm down, analysts told CNBC.com.

On Thursday, figures showed the UK economy fell deeper into recession than originally thought in the first quarter of this year with the Office for National Statistics saying gross domestic product shrank by 0.3 percent versus an initial estimate of 0.2 percent.

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On the same day official figures showed the biggest slide in retail sales figures in two years and one member of the Bank of England’s interest rate-setting committee indicated it would restart its asset purchase program if the economy weakened significantly, 10-year sovereign debt yields fell to record lows.

The contrast helped to highlight the UK’s position as a safe haven alongside Germany, which sold 4.56 billion euros ($5.8 billion) of new two-year bonds carrying a zero percent coupon with an average yield of just 0.07 percent.

But Britain’s safe haven status is at odds which much that appears to be happening. Two weeks ago the Office of National Statistics (ONS) revealed the UK economy was in the grip of a double dip recession.

Hot on the heels of that news came the warning from Mervyn King, the governor of the Bank of England that the UK was sailing through turbulent waters and was threatened by a storm in the euro zone.

And then on Tuesday the chief executive of the International Monetary Fund (IMF), Christine Lagarde warned British policymakers might need to consider cutting interest rates further and pursue policies designed to stimulate economic growth, much to the sneering displeasure of British finance minister George Osborne.

Osborne said on Tuesday the IMF supported the action taken by the Conservative-led coalition government, adding that the fall in inflation to 3 percent announced the same day, as well as falling unemployment and Britain’s continuing safe haven status for global investors, were proof the government was getting it right on the economy and that Britain had put its own “house in order”.

Years of Austerity Ahead

To some extent that’s true, according to Jeremy Batstone-Carr, director of private client research at Charles Stanley, but there is still a long way to go and many more years of austerity to endure first.

“It’s the view of the Conservatives that global investors have sought refuge in the UK as it is outside the euro zone. And I would tend to think that investors believe the UK has at least made a start to tackle its massive debt mountain through its austerity program. But it should not be forgotten that the austerity program has already been extended by two years in the last budget,” he warned.

Meanwhile Alan Clarke, economist at Scotiabank told CNBC.com he thought it was “good we got on with austerity earlier in many respects because there was always going to be fatigue for such policies further down the line.”

No one could give a concrete reason for Britain’s continuing safe haven status on the bond market beyond past performance being an indicator of future success.

”In reality global investors do believe that the UK economy does have the capacity to be competitive on the global stage. We have issues with an in inflated public sector but we do have a history of having a strong manufacturing base and a competitive economy, which given the UK’s safe haven status suggests people around the globe believe the UK has the capacity to be competitive again,” Batstone-Carr added.

Moreover Clarke suggested investors had wised up to the slew of economic data and bad press from around the globe and had made up their own minds about the state of the British economy.

He suggested the latest gross domestic product data from the ONS was questionable in terms of making comparisons to the euro zone in particular. “But if you look at the PMI data you can compare like with like and we are five or six points better off than the euro zone so we are doing alright,” he said.

UK already 'climbing out of the trough'

UK Climbing

In fact Clarke suggested that the UK was already “climbing out of the trough”.

“We’re through the worst of the recession now, inflation has come down from 5 percent at its peak to 3 percent now and so people have greater purchasing power. We’re in the trough and now we’re beginning to climb out of it. It’s not going to be spectacular but we are coming out of it,” he said.

Both Clarke and Batstone-Carr said the main difference between Britain and the euro zone was their relative competitiveness. In the case of the UK, investors believed it had the capacity to compete in the global economy while there were some euro zone member states that because of their lack of competitiveness would continue to drag on the overall economy.

“Politically the last couple of days have shown the robust impasse that European leaders are facing. The Germans have essentially ruled out the possibility of Eurobonds because they say they do not address the main issue of competitiveness in the peripheral nations,” said Batstone-Carr.

But even if there were agreement in the euro zone on issuing joint Eurobonds, it wouldn’t stop the need for austerity, according to Clarke.

"They can debate it all they like but it doesn’t stop the fact that for a decade everyone overspent so no one is going to escape austerity,” he said.