Brexit: Economy Update

Kingsley Thomas
The UK has not left the EU yet, and we have not had enough time to determine exactly what the impact will be over time. However, things don't seem as bad as we had feared.

In early June I published an article looking at the potential impact on the UK economy and our industry. At the time there were serious warnings about the impact of Brexit from most respected institutions and commentators, including the International Monetary Fund (IMF), Bank of England (BoE), World Bank, Office of Budget Responsibility (OBR) and many more.

In the article we looked at a worst case scenario with a sell-off of equities leading to a 25 percent reduction in the value of FTSE, a major increase in capital outflows, a 20 percent depreciation of Sterling, significant reduction in Foreign Direct Investment (FDI), a worsening of the Balance of Payments, a sustained increase in the Public Sector Net Cash Requirement, a reduction in built asset values, a higher cost of lending, high inflation, and increasing unemployment. There was dreadful doom and gloom.

Were the Predictions True?

The end of June and July saw a lot of fretting about what would happen to the economy on the back of the vote to leave the EU. On the 24th June there was a fall in the stock market and Sterling nose-dived. But, looking across the various indicators, things don’t seem too bad, and certainly not the doom and gloom scenarios set out by the respected institutions and commentators. In fact, the volatility on the stock market at the start of the year led by worries about the slowdown in China appears to have had more effect on businesses than the referendum. There are bigger issues in the world stage than Brexit, and certainly with the devaluation of Sterling you now get more for your money by investing in the UK.

The World Economy

According to the Organisation for Economic Co-operation and Development (OECD), Global GDP growth is projected to be around 3 percent in 2016 with only a modest improvement projected in 2017. This forecast is largely unchanged since June 2016 with weaker conditions in advanced economies, including the effects of Brexit, offset by a gradual improvement in major emerging market commodity producers.

The UK and Other Major World Economies

The table below shows the 15 largest economies using data from the IMF (GDP April 2016), and we use data from the Economist poll of polls for GDP forecasts. It shows the UK ranked 5th, however the depreciation in Sterling following the Brexit vote may put the UK in 6th position when you convert GDP to dollars. There was a further drop in Sterling to a 31 year low during the Conservative Party conference in early October from fears of a "hard Brexit". It is possible that the UK falls behind France this year and then behind India in 2017 due to the depreciation in Sterling and their stronger growth.

In red we have highlighted those economies that are forecast to perform worse in 2017, and it shows that the UK will have the most marked reduction in performance, joined by other Western Europe economies.

IMF economy data

The UK Economy

The economy expanded by 0.6 percent in the second quarter, picking up from 0.4 percent in the first quarter according to the Office of National Statistics (ONS), who also said there is no sign of the uncertainty having significantly impacted investment or GDP.

There are bigger issues in the world stage than Brexit, and certainly with the devaluation of Sterling you now get more for your money by investing in the UK.

The forecast for the UK has been downgraded following Brexit by forecasting organisations. The Economist poll of polls downgrades GDP to 1.6 percent for 2016 and 0.5 percent for 2017. However, in September the OECD improved the UK’s forecast to 1 percent for 2017 and the IMF forecasts 1.1 percent. Growth is predicted to rise to 1.8 percent in 2018.

Bank of England Reaction to Brexit

The BoE said that the UK economy will be 2.5 percent smaller than the Bank was predicting before the Brexit vote, but the UK should avoid a technical recession. Their chief economist said there needed to be a sledge-hammer approach to provide a large counter-jolt to the Brexit vote. Their counter-jolt had 2 key components:

  1. They have lowered interest rates to 0.25 percent, the lowest in the Bank's 322 year history. Mark Carney has also indicated that they may reduce interest rates to 0.1 percent by Christmas.
  2. Expanding the Quantitative Easing (QE) programme – The Bank has extended its QE programme by £70Bn to £445Bn. 

Of that, £60Bn will be spent buying government debt and £10Bn buying corporate bonds. This is intended to provide more money to banks’ reserves so they can make more loans at a lower rate.

The bank wants to give companies an incentive to raise funds for investment in their UK operations and maintain staff levels by making their costs cheaper. Only companies that make a material contribution to the UK economy will be eligible for the corporate bond purchases.

What is the Immediate Impact of Brexit in the UK – What is Really Happening?

There has been little impact of the Brexit vote on the UK economy so far, says the ONS. "The referendum result appears, so far, not to have had a major effect," its chief economist Joe Grice said. Official figures have not yet reflected the collapse in confidence predicted by some surveys since the referendum, and service sector figures released at the end of September by the ONS showed that there was growth in the sector in the first month following the vote to leave. This is an important indicator as the services sector accounts for 75 percent of UK GDP. Standard & Poor’s who downgraded the UK from its top AAA credit rating after the Brexit vote said that confidence indicators and data had been “quite resilient”.

Below is a review of the various economic indicators to consider the real impact on the economy.

FTSE

The FTSE 100 fell sharply the day after the referendum but quickly recovered and in August it hit a 14-month high, up about 8 percent on its pre-Brexit-vote level. In early October the FTSE 100 share index rose above 7,100 for the first time since May 2015, close to its record high.

FTSE100 up 18% FTSE250 up 6.5% since Brexit vote

But the FTSE 100 should not be misread as a barometer for the UK economy as many of these companies have material overseas operations. The drop in sterling therefore improves the finances of companies that take profits in dollars and convert it to Sterling. The FTSE 250 mid-cap index is far more exposed to the domestic UK economy. It too fell sharply after the referendum but is now at a record high with pre-Brexit vote gains of around 6.5 percent.

Exchange rates

There was a devaluation in sterling, as forecast, with Sterling falling against the Euro from EUR 1.18 from EUR 1.32 and against the dollar from $1.50 to $1.30. It is now at a 31-year low against the Dollar and a 5-year low against the Euro, and exports have been stronger as a result of our exports being cheaper.

GBPvUSD minus 15% GBPvEUR minus 10% since Brexit vote

Exports

The fall in the value of Sterling led to goods exports from the UK to other countries rising 3.4 percent between June and July. Exports to the EU, rose 9.1 percent, according to ONS figures. That was the biggest rise in EU exports since October 2010 and helped narrow the UK’s trade deficit with the rest of the world in goods and services when compared with a year earlier. The deficit on trade in goods came in at £11.8Bn, in line with economists’ forecasts.

Exports to EU increased 9.1% - UK Trade Deficit £11.8Bn

Inflation

Inflation rose to 0.6 percent in July and was also 0.6 percent in August, but jumped to 1 percent in September, which is the highest rate since November 2014, but remains relatively low and well below the BoE target of 2 percent. Economists are warning of steeper prices in the coming months as the full impact of the weaker pound following Brexit is felt. The BoE predicts that inflation will stand at 2.4 percent in 2 years' time.

2016 UK inflation

Employment

The BoE thinks that more than 250,000 people will lose their jobs as a result of the Brexit decision. The Resolution Foundation Think Tank estimates 320,000, and that the jobless rate at 4.9 percent will rise to 5.4 percent next year and 5.6 in 2018. But these are very gloomy forecasts, with official figures released in mid-August showing that the number of people claiming jobseekers allowance actually fell in the month following the referendum. The data also showed that the employment rate was at a record high in the run up to the vote at 74.5 percent.

House Prices

A total of 109,630 properties were bought in the UK during July, a very slight rise on a year earlier, HM Revenue and Customs data shows. Mortgage data has shown some signs of a post-vote slowdown, however the Royal Institution of Chartered Surveyors recently said that the UK housing market had "settled down" after the Brexit vote, with sales and prices expected to rise in the coming months. Annual growth in house prices fell from 9.7 percent in June to 8.3 percent in July. This continues to be strong growth driven by low borrowing costs and shortage of housing supply.

Public Finances

Public sector net borrowing (PSNB) was £10.5Bn in August, down £0.9Bn on a year earlier and £0.3Bn above market expectations. The August borrowing figure of £10.5Bn was higher than the £10Bn predicted by economists. But it was £900m lower than August 2015, giving a small boost to new chancellor, Philip Hammond. Overall for the financial year so far the deficit is smaller than in the previous year.

Autumn Statement

The Chancellor recently hinted in a parliamentary hearing that the Autumn Statement scheduled for 23rd November would see a splurge on UK infrastructure designed to boost growth in the wake of the Brexit vote. During the Conservative Party conference the Chancellor confirmed that HS2 will go ahead, that there will be significant investments in housing, and we will see more investment in an airport in the south east, which we now know relates to Heathrow.

Hammond has already indicated that he will focus on "modest, rapidly deliverable investments" on roads and railways. Some commentators suggest that Hammond may have an amount equivalent to two per cent of GDP to deploy in the Autumn Statement.

Outlook for Our Industry

On 4th October Faithful+Gould issued its UK Construction Intelligence Report, which details the outlook for our industry.

Sectors such as commercial and retail are struggling, however residential construction and infrastructure remain strong. European commercial investment in the first half of 2016 was down 35 percent on 2015, with uncertainty being a significant factor, but according to Cushman and Wakefield, this is likely to impact on activity levels rather than asset values.

Sectors such as commercial and retail are struggling, however residential construction and infrastructure remain strong.

The UK needs certainty on major infrastructure projects such as the Northern Powerhouse and HS 2 & 3.  The announcement on October 25th that the UK government is backing the 3rd runway at Heathrow is good news in principle, but some time from a final decision by Parliament.  At Faithful+Gould we are very pleased that Hinkley Point C has been given the go-ahead. All these investments make the country better. We hope Phillip Hammond will provide more positive news on near term investment decisions in the autumn statement.

So far, the UK and the construction industry is faring well following the vote to leave, however uncertainty continues to cause problems. We need certainly on government investment plans and encouragement for businesses to invest in projects.

Inspiration

With the uncertainty around Brexit it is easy to be negative in our outlook. However, we can all be confident about the future of the UK and its role in the world. Team GB is great inspiration for what we as a nation can achieve – they went out to compete with the rest of the world and delivered more Gold Medals in more sports than anyone else. They achieved that through focus, precision, and targeted investment. Brexit offers the UK the opportunity to re-set its position in the world, and there can be hope that Team GB’s Olympic success proves to be an analogy for the UK's continued economic success on the world stage.

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