Chances are of course that Brexit won’t turn out to be as bad a misjudgement as UK prime minister Neville Chamberlain’s ‘Peace for our time’ claim upon his return from the 1938 Munich peace conference. But only time will tell.
What’s more obvious is that Brexit Britain is finding itself between a rock and a hard place now, exactly a year after it chose to leave the European Union. The UK economy is slowing signs of serious deceleration, and prime minister Theresa May’s reckless election gamble has delivered the weakest British government in decades, at a time it is probably facing the most complex and politically delicate task a British government has ever encountered.
Brexit bites
In the aftermath of the Brexit vote, sterling plunged some 15% against both the dollar and the euro, and the currency hasn’t recovered since. Bank of England Governor Carney, who warned against the adverse economic consequences of Brexit before the referendum vote, responded to the Brexit vote by cutting interest rates, deemed by many Brexiteers as an overly pessimistic move at the time.
But economic performance, while initially holding up surprisingly well, has deteriorated significantly over the past few months. Foreign investment has plummeted and retail sales and business confidence have taken a hit. Rising inflation in combination with stagnant wages means a squeeze on living standards.
Stagflation scenario
GDP growth is still positive, partly thanks to the weak pound, but it is slowing (to 0.2% in Q1 2017). A stagflation scenario, with real growth slowing as inflation is rising, is now fast becoming reality, making Carney’s move to cut interest rates now look prescient rather than inappropriate.
It must be noted, however, that financial markets haven’t responded as badly to Brexit as many expected. Though markets were pricing in a Remain outcome ahead of the vote, sterling has been the only asset that has really been affected so far.
UK equities avoided a sell-off partly because of their large exposure to foreign markets, but longer-term they may also feel the consequences of Brexit. Lombard Odier IM, for example, has created a eurozone-only version of its European equity fund, following demand from clients.
“We have created a eurozone ex-UK share class alongside our original pan-European equity fund. Some of our French pension fund clients no longer want UK exposure because of Brexit,” he says.
Soft or hard Brexit?
Brexit negotiations only started this week, and it’s still far too early to tell what Brexit will really look like. European Council president Donald Tusk even suggested yesterday there is still room for the UK to reconsider its decision to leave the EU.
“Much will depend on how the negotiations progress over the next two years, and it remains too early to speculate on what the impact might be in financial markets. The fall of the pound in the aftermath of the hung parliament vote [on 8 June] was relatively modest (less than 2% against its major trading partners), suggesting that some expect the election result to produce a ‘softer’ version of Brexit,” said Jim Leaviss, head of retail fixed income at M&G.
