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Post-Brexit optimism not borne out by data

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2 nd August 2016
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The last couple of weeks have seen an array of mixed messages on how the economy is going to behave post Brexit. There have been a number of economic performance statistics and encouraging announcements which would, at first sight, infer that the consequences of the Leave vote will not be too severe. On the other hand, all the survey evidence post the vote has been, and remains, quite dreadful.

Last week’s announcement that second quarter GDP had risen by 0.6% was ahead of expectation, and initially looked promising until one realised that the growth was generated almost entirely during April, and in the following two months in the lead up to the referendum it came to almost a complete halt. One particular concern, on whether the UK will continue to be an attractive country in which to invest should it lose its gateway to the EU status, was mitigated by a number of announcements, notably Softbank’s acquisition of ARM – particularly its commitment to continue and increase that company’s investment programme. The rather smaller commitment from GSK was also encouraging, as was McDonalds’ announcement that its expansion programme would involve hiring an additional 5,000 staff – even if the thought is less than mouth-watering.

Unfortunately, the good news is only relevant to economic activity or investment planning that pre-dates the referendum vote by several months. Following the vote, the figures that first alarmed the market came from the flash PMI survey evidence that Markit produced, taking responses given within two weeks of the vote. That saw the manufacturing index fall to 49.1 (from 52.1) and the services survey collapse to 47.4 (from 52.3). As anything below 50 predicts a reduction in activity, the GDP outlook for the third quarter is not encouraging, especially given the service sector is the prime driver of the economy. Some forecasters hoped that when the figures had been updated with a full response, they might improve slightly. Unfortunately the reverse is the case, with the updated manufacturing figure released this morning showing a downward revision to 48.2. If the service sector were to show a similar contraction, there would be little doubt that the third quarter would show that the UK was moving into a recession.

The PMI survey evidence was so poor that it had the departing MPC member and long-term hawk Martin Weale proclaiming that the outcome was far worse than he had expected. Unfortunately, all it has done since is get worse. The latest CBI industrial trends survey was, if anything, worse than the PMI equivalent and its distributive trades survey showed retail sales over the past month falling faster than at any time over the past four years. Still, pride of place goes to the GfK consumer confidence survey. This had been expected to fall by around eight points over the month. Instead it came out 11 points lower. This is the largest fall in 26 years – considerably worse than anything seen as a result of the 2008 financial crisis.

It has to be emphasised that this is all survey evidence and it would not seem to be justified by ancillary information gained from company reports and general interviews. Furthermore, the mood might change very quickly once the Brexit shock and political shenanigans have dissipated. First up to try to repair the damage to confidence will be the Bank of England, on Thursday, with the production of its latest Inflation Report and the result of the MPC’s deliberations on monetary policy.

The MPC managed to annoy a multitude of economists last month by failing to announce any change in monetary policy, but is unlikely to repeat the performance this month. There seems to be almost unanimous agreement that the least it will announce is a 0.25% reduction in base rates and a further chunk of QE, probably of £75bn. While it is difficult to find an economist who does not think the MPC will take action this month, even if it probably means ‘looking through’ the quarterly report producing a forecast of inflation exceeding the 2% target level within the next two years, it is equally difficult to find any of those economists outlining any reason why that action will have any beneficial effect on the economy. A rate cut of 0.25% is unlikely to produce a saving for anybody other than those on a tracker mortgage or, possibly, borrowing on an overdraft. Very few mortgage lenders are likely to reduce their floating rate offers, and that assumes that the clearing banks pass on the MPC’s rate cut, which Lloyds called into question last week (while NatWest started to muse about the possibility of applying negative rates to deposits). Ironically, by squeezing the banks’ margins, a rate cut will actually reduce their lending profitability.

Another tranche of QE is likely, if anything, to be even more ineffectual. While QE was probably a very useful tool when introduced initially, it has long since lost any useful purpose as all it has done is produce an amazingly flat yield curve with 10 year gilts now yielding less than 0.70%. All that has happened with the more recent tranches of QE is that institutions have swapped out government bonds into other financial assets that will replace their long term income characteristics, largely property and property lending. This has been great for the property and related industries, but has not cut any ice in the real economy, as fully demonstrated in the Brexit vote.

The fact is that the MPC has pretty well run out of ammunition to support the economy through monetary stimulus. This is their own fault, as they should have ‘looked through’ very low inflation a couple of years ago when the economy was in good shape and raised interest rates then, thus giving them something worthwhile to bring to bear when needed. For any real impetus to the economy we will have to wait until the Autumn Statement and see what Chancellor Hammond’s fiscal policy ‘reset’ is made up of. It is just as well that the new government has already given up on producing a surplus in 2019/20 as the austerity measures already in the pipeline for the next two years are very considerable. Even if the new Chancellor prescribes a fairly major boost from near term infrastructure spending (housing, road repairs) and delays some of the austerity measures due to take effect next year, it is difficult to see how either a monetary or fiscal stimulus will do much to improve the economic outlook over the next few months.

All views expressed here are the author’s own and are based on information and data available at the time of writing.

 

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