UK economy post Brexit vote is an enigma

Posted on August 19, 2016

A workman installs concrete reinforcement rods during building works at Balfour Beatty Plc's St. James's Market construction site, a joint Crown Estate and Oxford Properties Group Inc. commercial real estate development, in London, U.K., on Thursday, Aug. 14, 2014. Balfour Beatty rejected a renewed merger proposal by Carillion Plc to form the U.K.'s biggest builder with a market valuation of about 3 billion pounds ($5 billion) because of a dispute over whether to dispose of the Parsons Brinckerhoff division. Photographer: Simon Dawson/Bloomberg┬ęBloomberg

Nearly two months after the UK voted to leave the EU, the question of how the economy would respond in the short-to-medium term remains unresolved. The one thing that seems clear is the impact on the rest of the world, which looks negligible.

As for the UK, early indications that consumer and business confidence were falling sharply have been somewhat contradicted by data showing retail sales and the labour market performed strongly in July. The wisest course for monetary and fiscal policymakers at the moment is to watch for new data and be prepared to react rapidly if necessary, with a bias towards loosening rather than tightening.

    In the days and weeks following the vote, the UK economy appeared to be encountering a major shock. Surveys of consumer and business confidence plunged. Sterling dropped against a range of currencies, notably the dollar.

    Wisely choosing to get ahead of the situation, the Bank of England cut interest rates this month as part of a package of monetary stimulus including an extension of quantitative easing, and indicated that it stood ready to do more. As recently as last week the National Institute of Economic and Social Research estimated that the economy had shrunk in July.

    Yet whether the BoE would feel compelled to make good on its promise was questioned by data released this week showing that retail sales volumes rose in July by 1.4 per cent, far higher than most economists in the financial markets had predicted. Those figures were followed by labour market data showing the number of people claiming unemployment benefit had fallen in July rather than rising as most forecasters had expected.

    By and of themselves, those two pieces of data do not add up to a refutation of the gloomy expectations for the UK. Strong retail sales have followed a positive shock to real household incomes from low oil prices and a price war on the high street, both of which are likely to fade. As for the labour market data, the wider measure of unemployment including all those looking for work rose rather than falling in July, though those monthly figures are notoriously volatile.

    Still, it remains striking that the survey evidence stands in such contrast to the hard data. The pollster GfK, which runs a respected and long-established barometer of consumer confidence, reported that the mood among shoppers in July recorded the biggest monthly fall since 1990, admittedly to levels that remained well above those seen during the global financial crisis.

    The contrast between that and the official retail sales numbers suggests surveys are particularly hard to read following an unprecedented type of shock with an unknowable impact on households and businesses. The forecasting ability of even well-respected indices may be weaker than usual in such a situation.

    Given this uncertainty, and bearing in mind that it has already acted, the Bank of England can afford to take a wait-and-see attitude for the moment until the stream of incoming data have pointed more definitely one way or another. Similarly, while the Treasury should also be looking to take advantage of the striking low long-term bond yields to fund infrastructure building, the degree of front-loaded fiscal stimulus that would be helpful in boosting the economy remains unclear.

    The UK economy may be humming along regardless of the vote, or it may be a cartoon cat that has run off a cliff but not yet perceived the abyss below. Until more data have provided guidance in this uncertain situation, policymakers should watch and wait.

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