Economic cost of UK uncertainty

Posted on September 22, 2016

House-price fear for city-dwellers...File photo dated 12/07/12 of houses in Muswell Hill, north London, as more than half of people believe they will never be able to own a house in the city where they live, a new study has shown. PRESS ASSOCIATION Photo. Issue date: Thursday February 19, 2015. Fifty-four per cent believe a lack of affordable housing will make their city unsuitable for the next generation, a survey of more than 2,000 adults revealed. The research, by paints company AkzoNobel, found many people believe cities will become unsuitable because of the high cost of living, lack of jobs and green space, and expensive houses. See PA story MONEY House. Photo credit should read: Dominic Lipinski/PA Wire©PA

In the three months since the EU referendum, Britain’s economy has been affected by two contrasting factors. On the one hand, consumer confidence has been strong, house prices have continued to rise and unemployment has been stable. On the other hand, British business leaders have become cautious, postponing and even cancelling future investment decisions.

Those two trends have been highlighted by several events in recent days. On Wednesday, the Office for National Statistics declared that the Brexit vote has so far had little impact on the UK economy. Meanwhile, the OECD said the immediate shock from the referendum was not as serious as had been expected, and has revised up its forecast for UK growth by 0.1 percentage points to 1.8 per cent this year.

    Even so, there are signs that business sentiment remains shaky. Today, for example, the first survey by the Federation of Small Businesses (FSB) since the referendum reveals the second-largest fall in confidence in the index’s history. Its survey of more than 1,000 small firms between July and August shows business confidence fell into negative territory for the first time since 2012. And there is anecdotal evidence that some international groups that had been thinking of moving staff or headquarters to the UK are having second thoughts.

    What are we to make of these contrasting trends? Clearly, predictions by economists and policymakers that Brexit would lead to an immediate fall in confidence and economic output have proved wide of the mark. A range of factors — most notably the Bank of England’s cut in interest rates in July — have helped to underpin sentiment. But there are two reasons why the current benign economic data provide little reason for cheer.

    First, UK-based businesses are likely to be living with uncertainty for a long time. Mrs May is giving no hint of what her Brexit plans are. Even when she does, negotiations will last for a considerable time. Uncertainty will lead to more investment decisions being postponed or cancelled. This is reflected in the OECD’s decision to revise down its UK growth forecast for 2017 by 1 percentage point. 

    Second, the sense that things are not quite as bad as expected comes at a critical moment politically. It is helpful to those politicians advocating a hard Brexit and emboldens those on the Leave side who like to cast the referendum as a victory — and who seem to think the UK can act as it did after the second world war, ignoring Europe and going it alone.

    The reality is simpler. Brexit has not yet happened. We do not know what kind of trading arrangement the UK will end up with. Until we do, the only certainty is that uncertainty will last.

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    Further reading

    Simon Nixon sets out why Britain’s withdrawal from European legal authority makes a hard Brexit more likely (The Times).

    Investment banks believe the City of London will eventually be stripped of the ability to clear euro denominated swaps (Bloomberg).

    Oxford’s dominance among global universities raises questions about the impact of Brexit on the higher education sector. 

    Hard numbers

    From FT markets:

    For weeks, one part of financial markets was ahead of the pack in preparing for Brexit. While opinion polls pointed to a Remain victory, traders of currency option contracts, which give the right but not the obligation to trade at a set price in the future, were not so sure.

    The cost to insure against a large fall in the value of the pound surpassed prices reached during the financial crisis. On the other hand, the foreign exchange spot market was happy to trade sterling in line with opinion poll movements, meaning the pound touched $1.50 shortly after polls closed on the day of the vote.

    In the event, sterling dropped to a 31-year low, in line with a large number of forecasts. The options market continued to be heavily bearish towards sterling post-Brexit, until economic data in recent weeks forced a rethink.

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