Weakness in Eurozone affects UK equities

May saw UK All Companies funds squeak ahead of the UK Equity Income sector for the first time this year as managers in the latter grouping were hit by the problems at BP.

The FTSE 350 Low Yield index dipped 5.8% over the month, while the equivalent High Yield index fell 7.6%. That said, the UK All Companies sector has still been one of the worst-performing of all the major markets in 2010. Since the start of the year, it has dipped 2.21%, compared to rises of 7.73% for North America and 11.57% for Japan. Only the eurozone – unsurprisingly – has performed worse, with the average Europe excluding UK fund down 9.66% since January.

The FTSE 100 was one of the better performing markets in May, down ‘just’ 6.6%, compared to falls of 8.4% for the S&P 500 and 10% for the Nikkei. However, this was more by virtue of relative inactivity after the volatility surrounding the election, than any obvious signs of strength.

Some more optimistic signals did emanate from the UK economy. GDP figures for the first three months of the year were revised up from 0.2% to 0.3% while output was given a boost by a strong rebound in industrial production and business services. This latter point cheered some economists who took it as a sign the UK economy was finally rebalancing away from a reliance on consumer spending into industrial production. Industrial output showed growth of 1.2%, compared to a previous estimate of 0.7%.

The first moves by the new coalition Government to rein in public spending were announced. The moves to cut £6.2bn from the public purse were welcomed by rating agencies and more cuts are expected in the Budget on 22 June.

Even so, this did not stop the OECD issuing a surprise warning on interest rates. The organisation said UK rates needed to rise to 3.5% by the end of 2011 in order to stave off increasingly insistent inflationary pressures. The comments were robustly dismissed by many economists, who believe raising rates at the same time as tax rises and cuts in public spending would be suicidal for any recovery.

The UK’s biggest problem at the moment is the weakness of the eurozone, which remains its biggest trading partner, meaning its current problems could destabilise the UK’s anaemic recovery. Any significant deterioration in the euro may also hamper the competitiveness of British exports, which have benefited from the consistent weakness of sterling.