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BREXIT: YOU EITHER LOVE IT OR HATE IT

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18 th October 2016
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It had been foretold by some for months, but last week the apocalypse finally arrived – the British public were denied access to their beloved Marmite. Outcry was heard from many as the masses demanded to know why they weren’t told of this possibility before voting for Brexit. And then, a brief 24 hours later, normality resumed and Marmite was back on the shelves.

It turns out Unilever was just trying to exploit current markets by demanding a 10% increase on previous prices as a result of increased cost bases. This figure has already been analysed and found to be an exaggeration, and 4-5% at most is a more accurate assessment of the increase necessary at this point in time. The lesson we can learn from this episode of media frenzy is not to take everything at face value. Unilever may be the first caught ‘crying Brexit’ when in fact they just want to increase profitability, but they absolutely won’t be the last.

Inflation seems to be the hot topic at the moment, be it on toast spreads or otherwise. Mark Carney and the other Bank of England board members spent most of last week giving speeches reiterating their position that inflation is likely to rise above the 2.0% target for a brief period, probably to 2.5%, before turning back towards the target level. Markets don’t appear to believe this and have priced in an implicit inflation level of 3.0% for the next five years.
 
This combined with a number of other effects is playing into the interest rate markets which have started to rapidly increase since the start of the month. A five-year Q/Q swap was only 0.35% on 1 October, but this morning that had nearly doubled to 0.69%. So what changed?
 
The most important factor playing into this movement relates to the aforementioned inflation expectations. Given the massive swings in GBP, most predominantly 10 days ago, markets have started to foresee substantial inflation on the horizon resulting from a currency crisis which would, in turn, lead to increases in interest rates.
 
The trigger for this set of events would, it is widely supposed, be continued fears of the government boxing itself into a so-called ‘hard-Brexit’. Every time this is mentioned GBP takes a tumble. However, sterling has now become so competitive compared to its pre-referendum levels that Brexit would have to be diamond-hard to force the currency much lower – particularly given the higher yields suddenly available on gilts.   
 
An interesting rift has opened in the last couple of weeks between Theresa May and Carney following May’s speech which essentially blamed the Bank of England’s ultra-loose monetary policy for assisting asset holders to the deprivation of the poor and pension savers. Although this has undoubtedly been the outcome, it is very unfair to take aim at the central bankers in hindsight, given that the rationale of implementing such a policy was to stabilise and support the general economy. Regardless, the implication is that the government is planning to push for a reversal of low rates in order to primarily assist pension savers, and hopefully reduce the massive deficits currently displayed by most pension schemes. The Bank of England/MPC are independent of governmental meddling and so will only raise rates when they see fit, as Mr Carney stated explicitly last Thursday. This makes the second time in a week that markets have ignored his statements as rates continued to rise.
 
The markets may have surer footing in this respect compared with the inflation stance. Firstly, although it is true that the Bank is independent and makes its own policy decisions, the government can change the Bank’s mandate and targets. Therefore, it would not be beyond the realm of possibility for them to change the mandate to fit the government’s policy. After all, independence was granted to the Bank of England not to stop the government from achieving the overall aim of monetary stability, but to stop them meddling with monetary policy for short-term political ends. Secondly, despite much commentary to the contrary, the government can replace the Governor. Osborne undoubtedly had a good hand to play in the choosing of Carney and, whatever the relative merits of replacing him with someone who is aligned with May’s policies, it is highly likely that if relations become strained Carney will be pushed to resign.
 
From a market perspective, the problem with the Brexit process is the lack of hard facts, which is leaving the media free to speculate and market participants clueless. The news that May has not ruled out continuing to pay an EU subscription to maintain privileged access to the single market will have enraged eurosceptic Tories but, if confirmed, it will support the pound and gilt markets. Unfortunately, there is going to be a great deal more speculation as to the shape of Brexit ahead of the triggering of Article 50, at which point, things will almost certainly become more fraught as the real negotiation begins.
 
Tomorrow has the release of September’s CPI figures for the UK. Current forecast is an uptick to 0.9% year-on-year from 0.6% last month. As described above, expect currencies to move quickly if the actual data deviates too far from the expectation. Wednesday has the UK’s unemployment data releases for August. Currently, no change is expected from the 4.9% unemployment rate shown for the last few months.
 
Thursday sees the ECB’s monthly meeting. All ears will be listening to see if there are any further comments around the potential tapering to the asset purchase program. Markets reacted badly to such an implication a few weeks ago and Draghi may wish, at a minimum, to state support for the existing program running to completion.
 
From a US perspective, the highlight of the week is Wednesday night when the third presidential debate is held. This will be the final head-to-head the two candidates will have, and thus the last opportunity for the public to rate them before heading to the polls in three weeks.

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