Posted on: 13 October 2016
As politicians, multiple Government departments and influential think tanks debate what the EU referendum actually means for the UK post-Brexit, The Commentary considers the economic effects.
A strong FTSE 100 Index, but Sterling at a record low
Over the past week, UK equity indices have set new highs. The Prime Minister announced, at the recent Conservative Party Conference, an end of March 2017 as the target start for Brexit, which is expected to happen by summer 2019. While there is uncertainty over what the final terms will be there is significant pressure on Sterling as it fell to a 31-year record low against the US Dollar and six-year low against the Euro.
UK equities have responded positively to the weaker currency because many have overseas operations that will see earnings flattered by the translation effect of the exchange rate, and others will see a benefit as their goods become cheaper on international markets.
Hard Brexit or Soft Brexit
Speculation continues on the impact on the UK economy of a hard Brexit versus a soft Brexit, defining what the UK status would be and arrangements going forward for membership of the single market, tariffs and trade.
A growing number of senior politicians are also demanding a debate in parliament and vote on the terms of our exit. The current Government position is that MPs will not get a formal vote on Brexit negotiations, but there is agreement to demands for a debate before triggering Article 50 of the EU’s Lisbon Treaty, which starts a two-year process for Britain to leave the bloc.
With so much ‘noise’ in the market, there are any number of market indicators informing the debate.
The US financial services firm Morgan Stanley said it would not rule out "a soft Brexit just yet". It sees two routes to a "softer outcome":
- Given a divided country and a narrow majority, the politics could change, particularly if the prospect of a more disruptive Brexit starts to impose a visible economic cost.
- It still sees space, although now more constrained, for some elements of shared decision-making to allow enhanced UK access to European markets.
The British Chambers of Commerce (BCC) has just published its first Quarterly Economic Survey (QES) since the EU referendum, with the survey showing an improved short-term performance in the manufacturing sector, set against a further slowdown in growth in the services sector - which accounts for more than 75% of British GDP.
QES is the largest independent business survey in the UK. It is gathered from responses by 7,076 businesses, who were asked about a wide range of issues from domestic sales and orders, to investment prospects.
Director General of the BCC, Dr Adam Marshall said: “While many manufacturers have seen something of a bounce this summer, the UK’s services sector has slowed significantly, and our data suggests that slower growth is likely in the months ahead.”
The survey shows that manufacturers enjoyed improved domestic and export sales compared with the previous quarter, with some benefitting from Sterling’s recent fall. However, the balance of service sector firms reporting improved domestic and export sales was at the lowest level seen since 2012.
The survey’s results suggest that the UK economy is still growing – albeit at a lower level than before the referendum – and supports the BCC’s forecast for growth of 1% in 2017. Previous forecasts were for 1.8% growth. It shows that uncertainty following the vote has led businesses to lower their expectations for hiring, turnover, and investment in plant, machinery and training.
The Office for National Statistics has also released figures showing the UK’s trade deficit widened in August as the value of imports jumped in the face of the weaker pound.
In total the ONS figures showed UK bought £4.7bn more from abroad than it exported over the month of August, a nearly-doubling of the deficit from the £2.5bn recorded in July. The value of exports rose by just £100 million. While imports surged by £32.6bn as weak Sterling meant UK firms and customers had to pay more for foreign goods.
The cost of imported goods rose by 6.5% over the year, the ONS said, in a sign of inflationary pressures which are building in the UK economy. "The general consensus among economic commentators is that the recent depreciation should boost export and manufacturing competitiveness," the ONS said.
Last week's figures however show the reality may not be quite so simple, especially if consumers and firms just swallow the higher prices. The ONS added: "In general, a close long-run relationship between export and import prices is to be expected, as other factors such as raw material and labour prices are also significant drivers.
The Autumn Budget Statement and infrastructure projects
Commentators this week have also said currency markets will be keeping a very close eye on the Chancellor’s Autumn Statement on 23 November to see if any new announcement will add positivity, helping to reverse the recent weakness of the pound.
In addition the BCC has also urged the Government to use the Autumn Statement to boost business confidence – by giving the green light to key infrastructure projects such as a new runway for Heathrow and HS2 (a high-speed rail project between London and the North of England). Both projects have been controversial but the Government’s recent decision to override Lancashire County Council on fracking demonstrates that they are willing to take unpopular decisions on these projects.
What does this mean for client portfolios
Our client portfolios have benefitted from the rally in equities and the devaluation of the pound has been beneficial for international exposure in Sterling terms. However, we are mindful that valuations are at very high levels leaving equities vulnerable to volatility and even small corrections. We are therefore hestitant about increasing risk too much in this environment.
Something that the market is currently not pricing-in is higher inflation. This appears inevitable in the UK due to the weaker currency, but may also become an issue in the US where the economy is rapidly reaching full employment and wage inflation is becoming entrenched. Protecting client portfolios from the long-term erosion of inflation is something we are very conscious of and incorporate into our portfolio management decision-making.
All data has been compiled by Duncan Lawrie from sources believed to be reliable. Full details of sources are available on request.
The comments and figures in this document are generally applicable but you should always take specific advice to suit your individual circumstances before taking any action. Errors and omissions excepted.
The value of investments and income generated may fall as well as rise, and investors may not get back the amount invested. Past performance is not a reliable indicator of future results.