Why
Brexit hasn’t destroyed the British economy (yet)
Since
the referendum, UK consumers and businesses have defied the
doomsayers. But the day of reckoning has only been delayed.
By
Francesco Guerrera
9/11/16, 6:00 PM CET
LONDON — It was
supposed to be a summer of discontent.
But after the Brexit
vote, many Britons feel they have never had it so good.
In the early hours
of Friday, June 24, as Britain’s shocking decision to leave the EU
dawned on the world, economists of all stripes took out their red
pens, slashing forecasts and predicting short-term woes and long-term
pain. Their consensus view, shared by many experts, including
POLITICO, was that one of Europe’s strongest economies would
sputter in 2016 and grind to a halt next year.
Credit Suisse
headlined a post-referendum research report “Mayday! Mayday!”
while Morgan Stanley’s economists spoke of a step “into the
unknown.” All of a sudden, the warning of a “DIY recession”
from then-finance-minister George Osborne in the run-up to the voting
appeared close to becoming a reality.
A new moniker was
coined: “Brecession.”
Less than three
months later, the doomsayers are beating an embarrassing retreat.
Financial analysts
and economists are now busy revising their predictions upwards and
scrapping calls of a 2017 recession, defined as two consecutive
quarters of negative growth. After being wrong-footed by the
referendum result, the City of London and assorted pundits have been
fooled by its economic aftermath.
Far from being
hampered by the uncertainty surrounding the vote, the British economy
accelerated in the three months through June, driven by strong
consumer spending, a big improvement in industrial production, and
business investment. And the picture has remained positive, albeit
not as rosy, since then, with preliminary data showing manufacturing
and services holding up well, and retail sales stronger than
expected.
What went right?
Brexit supporters
are already taking victory laps. “I see no circumstances where the
Brexit vote can cause a recession in the U.K.,” John Redwood, a
leading Conservative Euroskeptic, told POLITICO’s Tom McTague.
What went right for
the U.K economy after the vote? And can Britain really survive a
historic break-up from its biggest trading partner with just a few
scrapes? The answers are, respectively: “A lot” and “not really
— in the long-term.”
Political
developments, for once, also helped. Instead of descending into
months of internecine strife, the ruling Conservative party was able
to swiftly appoint Theresa May.
First, the good
news. The British economy didn’t fall off a cliff after June 23,
thanks to a benign confluence of previous momentum, a swift political
entente and radical action by the Bank of England.
In 2015, the U.K.
was one of the best-performing economies in the developed world,
notching up a 2.3 percent growth rate, a smidgen below that of the
U.S. (2.4 percent) but way ahead of the 1.6 percent recorded by the
eurozone, according to the Dutch bank ING. Employment soared to
levels not seen in more than a decade, while low-interest rates and
even lower inflation kept the housing market humming and consumers
shopping.
Economists say that
when an economy is growing like that, it’s difficult to knock it
off its tracks, partly because a lot of investment and spending
decisions are locked in for the long term. Companies, for example,
prefer to reduce margins, dip into reserves, or hike prices before
cutting their workforce or reversing investment decisions. And
individuals loathe changing their spending patterns unless there’s
a life-changing event — like layoffs.
Political
developments, for once, also helped. Instead of descending into
months of internecine strife, the ruling Conservative party was able
to swiftly dispose of the referendum-losing Prime Minister David
Cameron and appoint Theresa May as his replacement in a matter of
days. May, a Remainer before the vote, formed a Cabinet that seemed
to balance the views of the Out camp — three key Brexiters were
given big jobs — with the pragmatism needed to get a deal out of
the EU.
What economists
appeared to have gotten wrong is the timing of a Brexit-induced
slowdown.
“Many were
expecting the Tories to really implode. That didn’t happen,” said
Jean-Michel Six, chief economist for Europe, Middle East, and Africa
for Standard & Poor’s. “The conservatives demonstrated an
amazing ability to move to the next step, forget about Cameron and
appoint a new PM that impressed markets and public opinion. That was
very reassuring.”
The Bank of England
compounded the feel-good factor in August by throwing “the kitchen
sink” at the economy, as Robert Wood at Bank of America Merrill
Lynch put it. Among other things, the BoE’s move made the sterling
weaker, helping British exporters and boosting inward tourism.
The first BoE
interest rate cut since 2009, coupled with other stimulus measures,
also sent a powerful message to markets, companies, and consumers
alike: That the country’s monetary authorities will not be standing
idly and let Brexit wreck the economy.
Tougher times lie
ahead.
For a start, not all
indicators continue to point upwards. On the consumer front,
high-street sales have suffered after a strong July, falling 1.5
percent in August compared to a year ago, according to accountants
BDO. And on the business side, an industrial trends survey from the
Confederation of British Industry in July showed that optimism about
the business situation over the previous quarter had fallen at the
fastest pace since January 2009. The CBI also found that companies’
desire to invest in buildings and factories had fallen sharply.
As doubts grow over
Britain's relationship with the EU, many expect the foreign money to
stay away, making it less possible for Britain to "rely on the
kindness of strangers," as Mark Carney, the governor of BoE, has
said, citing American playwright Tennessee Williams
As doubts grow over
Britain’s relationship with the EU, many expect the foreign money
to stay away, making it less possible for Britain to “rely on the
kindness of strangers,” as Mark Carney, the governor of BoE, has
said, citing American playwright Tennessee Williams | Justin
Tallis/AFP via Getty Images
What economists
appeared to have gotten wrong is the timing of a Brexit-induced
slowdown. Instead of fretting about investments and tightening belts
immediately after the vote, the Britons had a leisurely summer in the
(relatively) good weather, enjoyed the country’s Olympics successes
and took advantage of the benign political and monetary situation to
carry on spending.
But that has only
delayed the day of economic reckoning. A tidal wave of uncertainty is
about to hit Britain’s political and economic landscape as the
country embarks on treacherous talks over its future relationship
with the EU.
“We think the key
risk event is the point at which Article 50 is triggered, i.e., the
formal notification of the U.K.’s intention to Leave the EU, which
we currently expect in the first quarter of 2017,” wrote Morgan
Stanley economists Melanie Baker and Jacob Nell in a recent note.
As for consumers,
the most important determinant of their spending is whether they have
a job or not. As a result, consumer spending tends to lag, rather
than lead, any economic contraction. In the view of Kathrin
Muehlbronner, lead U.K. analyst at Moody’s Investors Service,
British consumers will start to feel the pain of a Brexit downturn
only when the job market weakens, something that might not happen
until next year.
Less acute but more
chronic pain
Indeed, some
economists, like ING’s James Knightley still forecast a Brecession
in 2017. A delayed timetable doesn’t mean the pain will be any less
pronounced. “The drag on growth looks less acute than we had
expected but may be more chronic,” Bank of America’s Wood wrote
to clients.
Much will depend on
how foreigners behave. Not, mind you, the foreign workers that
hard-line Brexiters want to keep out, but overseas investors such as
the Japanese car companies or Chinese real estate buyers that have
been funding Britain’s gaping current account deficit. As doubts
grow over Britain’s relationship with the EU, many expect the
foreign money to stay away, making it less possible for Britain to
“rely on the kindness of strangers,” as Mark Carney, the governor
of BoE, has said, citing American playwright Tennessee Williams.
To be clear, U.K.
policymakers can, and will, try to counter these negative effects.
New Chancellor of the Exchequer Philip Hammond is due to unveil his
first fiscal measures on November 23 and is certain to reverse the
austerity of Osborne and add tax cuts and spending plans to stimulate
the economy. And the BoE could cut rates further and add to its bond
purchases, going down the stimulative path blazed by the U.S. Federal
Reserve, Bank of Japan and European Central Bank.
But those actions
may not be enough to stop a once-booming economy from hitting the
wall — or at least braking very hard before it.
Even May has
admitted that “there may be some difficult times ahead.” By next
year, that could be seen as a stunning example of British
understatement.
Silvia Sciorilli
Borrelli contributed reporting.
Authors:
Francesco Guerrera
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