Brexit? What Brexit?
Perhaps the “Leave” campaign was right: maybe nobody should listen to “experts”, especially economists.
In the wake of the UK’s referendum vote, economists reduced their outlook for domestic growth. According to the Treasury’s survey of independent economists, the outlook for 2017 GDP growth has dropped from 2.1% prior to the June referendum to just 0.7% in the latest survey in August.1
However, the summer data has been surprisingly strong and an immediate slowdown appears to have been avoided. Major data points, listed below, have all come in above expectations:
- Services purchasing managers’ index (PMI) for August – 52.9 vs. expectations for 50.0
- Manufacturing PMI for August – 53.3 vs. 49.0
- Industrial production for July – 2.1% year on year (y/y) vs. 1.9% y/y
- Retail sales for July – 6.2% y/y vs. 5.3% y/y2
Does the recent bounce in economic data mean that the UK economy is out of the woods? The answer is probably not. It will take some time for the full effect of the Brexit vote to be reflected in economic data. Looking at the Bank of England’s (BoE) own forecasts, business investment is expected to begin to contract in the coming months as firms look to scale back their UK operations gradually over the course of this year. These expected cutbacks in investment would begin to hurt the consumer in 2017 and 2018 as workers are laid off and unemployment begins to creep back up. As consumers make up 60% of UK GDP3, it is likely that it won’t be until 2017 and 2018 that the threat of a pronounced economic slowdown begins to potentially creep in.
At present, there is no such thing as
“Brexit”. All we have had is a national vote on the subject, and the only major
changes on a macroeconomic level have been the fall in the currency and a
package of measures from the BoE—both of which are pro-growth. Ultimately, we
cannot be sure what comes next for the UK as we enter these uncharted waters.
We still have scant little detail over when Article 50 will be triggered, how
long exit negotiations will take and what the final deal will look like. With
so many unknowns, measuring the impact of Brexit is challenging.
The below chart from our Guide
to the Markets outlines the dynamics of the exit negotiations. Ultimately,
there will be some trade-off between the sharing of sovereignty, free movement
of labour and access to the single market for goods and services. The best way
to view this chart is by separating the outcomes into a “soft” vs. “hard”
Brexit. In a soft Brexit scenario, we would end up negotiating terms similar to
those of Norway. This would involve us retaining access to the single market, but
it would come at the cost of continuing to pay into the European Union (EU)
budget, implementing a large proportion of EU laws and continuing to allow the
free movement of labour. However, under a soft Brexit scenario, the economic
fallout of breaking away is minimised as businesses can continue to be based in
the UK and still operate across Europe. Under a hard Brexit scenario, we would
lose our access to the single market, which would result in more firms
uprooting and moving over to Europe, and would be economically the most adverse
TRADE-OFFS FOR THE UK
Source: J.P. Morgan Asset Management, Guide to the Markets – UK. Data as of 30 September 2016.
We have had much debate, but little detail, about the future path of the negotiations. One of the challenges for the British negotiators is that although a soft Brexit is economically favourable, it is not a politically favourable outcome. Many voters who opted to leave the EU did so because they wanted to limit the movement of labour, stop paying into the EU budget and regain some sovereignty. The concern is that very little of this could be achieved under a soft Brexit scenario.
Overall, investors should expect a period of prolonged uncertainty surrounding the nature of the UK’s relationship with the EU, resulting in sluggish—but still positive—UK economic growth. This, in turn, is likely to see monetary policy remain looser for even longer and the pound continue to trade close to multi-year lows against other international currencies for the foreseeable future. The challenge for investors is how to position their UK equity allocation in such an economic and political environment.
Read more about J.P. Morgan Asset Management’s UK equity fund range:
1 Source: Bloomberg, data as of 30 September 2016. 2 Source: Bloomberg, data as of 30 September 2016.3 Source: ONS, data as of 30 September 2016. | UK Asset Managers
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