The UK economy: life after Brexit
How well prepared is the UK economy for life after Brexit, deal or no deal?
Analysis and comment on the UK are understandably focused at present on the political shenanigans surrounding Brexit and the preparation (or lack of it) for ‘No Deal’. This has distracted attention from the economy. In this note, we examine how well prepared the UK economy is for a future beyond Brexit. We will not be concerned about the immediate disruptive effects of a no-deal Brexit – the so-called ‘bumps in the road’ – but the likely performance thereafter.
We conclude that the UK will continue to grow even with a no-deal Brexit, notwithstanding temporary disruptions, but that the pattern of growth may change significantly.
Divergence between the Consumer and Businesses
Whilst business confidence and investment have been on a declining trajectory given the gloomy global backdrop and continuing uncertainty over the nature of the UK’s exit, the British consumer has no such qualms. Consumer confidence has been picking up on the back of rising real incomes, low unemployment and record low mortgage rates. There is no evidence of any Brexit-induced brake on spending here.
The chart below compares the European Commission’s Economic Sentiment Indicator for consumers’ overall confidence (blue) to an average of the EC’s ESI for Industry, Construction, Services and Retail weighted by each business sector’s share of GDP as at 2016 (orange). This equates to approximately 14%, 6%, 70% and 10% respectively.
Source: Pantheon Macroeconomics, European Commission as at 13 August 2019
July’s retail sales figures were surprisingly strong and consumer spending, up 1.8%, accounted for all of the growth in the latest figures for GDP in the year to Q2 2019. By contrast, business investment fell by 1.6% over the same period.
The problem is that consumers have been spending ahead of their incomes: the saving ratio has declined by five percentage points since the Brexit referendum. This move cannot be repeated. If, as seems likely, a no-deal Brexit is accompanied by a further decline in sterling and household incomes are reduced by another rise in import prices, this is likely to feed through more directly into lower consumer spending.
UK saving as a % of income for households
Source: BMO Global Asset Management and Bloomberg as at August 2019
Businesses, in contrast to consumers, have been cautious about increasing investment spending, which would normally be increasing strongly at this stage of the cycle. This caution can be linked to the uncertainty surrounding Brexit. This uncertainty will be with us for years to come as we have yet to address our future trading relationship with the EU and a myriad of regulatory and other issues have yet to be resolved.
Support from Monetary and Fiscal Policy
This all suggests that the economy will be in need of substantial support in 2020. The good news is that this is likely to be forthcoming. The government has announced a whole host of prospective fiscal measures, such as tax cuts and spending on areas from the NHS to education and the police, with the Chancellor Sajid Javid due to announce a Spending Review in September.
Typically, a Spending Review would distribute cash among government departments over a three-year period after the overarching budget framework has been set. However, this one is likely to be different and is more likely to be a ‘mini Budget’ where Prime Minister Boris Johnson’s pre-election spending pledges will be incorporated into department allocations. Until such time as the full budget is presented, and this is unlikely to be until November/December, we can’t be sure how much this fiscal loosening will equate to, although based on the willingness of Johnson and Javid to use up the buffer against the Fiscal Mandate, it could be around £20bn.
As an aside, the Fiscal Mandate is to achieve a structural deficit of less than 2% by 2020-2021, which was deemed to be met by 1.2% of GDP at the time of the Office for Budget Responsibility’s Spring Statement i.e. the structural deficit is expected to be 0.8% rather than the 2% limit.
It is also possible that Javid will ditch this rule of his predecessor Philip Hammond and replace it with the looser commitment of merely reducing debt-to-GDP each year in order to create room for more public borrowing. Ultimately, a fiscal boost equating to 1% of GDP is not an unreasonable expectation of the Budget to both support the economy and consumer in the event of a no-deal Brexit, as well as attract voters in the event of a post-Brexit general election.
The Bank of England eased monetary policy after the Brexit referendum, providing considerable support to the economy. They have warned that they may not be able to deliver a repeat dose in the event of a no-deal Brexit. This would constitute a supply shock they argue, which might increase longer-term inflation pressures. We doubt these concerns will prevail and expect a cut in base rates, a revival of the term funding scheme and, perhaps, further quantitative easing.
And if there is a general election?
An early general election looks increasingly likely. Opinion polls have been a poor guide to recent UK elections and the uncertainty is only increased by the reformulation underway in British politics. Whatever the outcome, we would expect a major fiscal expansion; only the composition would change depending on the party, or parties, in power.
The UK is undergoing dramatic changes as a result of Brexit, and the traditional pattern of strong consumer strength may be called into question. Policy support will limit the immediate damage to growth but the longer term policy outlook is deeply uncertain, given the political background. Nevertheless, we should not forget that while Brexit is a major challenge, the UK has a highly competitive currency, and an open economy with a well-educated and flexible labour force.