It would be reasonable to think that UK stock markets have been on a sugar rush from shortly after the Brexit Referendum in June until late October. Equity markets forged ahead as the pound devalued, taking the hit for the uncertainties of the leave result. Sterling stood at 1.48US$ prior to Brexit only to fall to 1.28US$ soon after.
British business has benefitted as its products and services cost less abroad due to the weaker pound. This has made British products more competitive and increased export sales. At the same time, the resulting repatriated profits are further boosted by currency exchange terms. This boost to business has been positive, but is not fundamental and will slow as sterling recovers ground and the impact of Brexit becomes clearer.
Back in early June, two weeks prior to the UK referendum, we recommended a move from UK and European equity into the safety of cash. On the Monday after the poll, we recommended a return to these markets as values in the FTSE 100 index had fallen by 6%. Sterling then acted as the nation’s shock absorber giving our exporters a massive price advantage. The FTSE swiftly grew from 5980 in late June to 7097 in early October, a gain of 18%. We have already seen most of that growth fall back with the FTSE 100 standing at 6752 on 1st December. There recent falls can be attributed to the High Court ruling over the government’s right to avoid a parliamentary vote on the triggering of Article 50, the uncertainty over the US Presidential election and more recently concerns over the frailty of Italian banks. The election of Mr Trump did not bring the market falls many had suggested. In fact US markets have responded very positively to Trumps victory and have significantly rallied with both the S&P 500 and Dow Jones index hitting alltime highs in late November.
Theresa May has committed to a March 2017 start to the negotiations on Britain’s exit from the EU. This act will formalise the uncertainty and early rounds of negotiations can be expected to be more about positioning than agreement particularly with elections due in Holland, France and Germany next year. It is therefore reasonable that sterling could maintain a relative lower value for some time while the uncertainty of Brexit remains.
Mark Carney, the Governor of the Bank of England (BoE), maintains that the drop in our currency value has been based upon a mistaken analysis of the state of the UK economy and its future prospects. He thinks markets have priced in a ‘Hard Brexit’ where the UK reverts to a world trade agreement position leading to both import and export tariffs being charged. Mr Carney is hoping for more mutually beneficial outcomes from the ensuing divorce negotiations.
The latest GDP figures for the UK saw a 0.5% growth in Q3 matching the prediction made by the Office of Budget Responsibility (OBR) prior the referendum. Economists expect that any post Brexit slowdown will be much milder than forecasted. The expectation for 2016 annual growth is 2% with a reduction to 1.4% growth in 2017 as the full impact of Brexit becomes clearer. Similarly, the BoE also expects the UK economy to grow 1.4% next year with inflation set to rise to 2.7%. This is a threefold increase in current inflation rates. With a declining outlook for the UK economy, the BoE kept interest rates on hold at 0.25%.
The Office for National Statistics (ONS) confirmed that UK unemployment fell to 1.6 million in September, hitting an 11-year low. The jobless rate fell to 4.8% while the total number of people in work was at a record high of 31.8 million.
We feel that a UK rate rise will now not take place for up to three years over the Brexit negotiations period, leaving UK savers with little to look forward to. Inflation will be pushed up by a number of factors, including the impact of the falling pound causing an increase in the cost of imported goods, the rise of fuel costs and the start of wage inflation due to higher levels of employment. However, due to the expected fall in GDP growth and any recovery in the value of sterling could result in lower levels of inflation than are currently predicted. If however, the Brexit negotiations stall and sterling falls again inflation may rise above 3%.
Many economists believe that sterling has been over valued for some years and that our economy is overly reliant on the financial services sector. Several have argued that if a more balanced economy is desirable then sterling’s fall is beneficial. It could bring about higher interest rates and consequently lower house prices, improved productivity and a manufacturing revival. The obvious downside for consumers is that imported goods will be more expensive and the cost of living will rise. We in the UK import 40% of our food and 90% of our clothes. There can be long term advantages, however the short term disadvantages will start to have an impact in the New Year.
It is not only the stock market that has enjoyed a post Brexit boost. The car industry and tourism have enjoyed strong growth. The Confederation of British Industry (CBI) revealed that its trend surveys showed manufacturing orders from foreign customers hit its highest level in Q3 for three years and that the outlook for Q4 was also very good.
We can expect Brexit related uncertainty to dampen some business investment irrespective of the recent Nissan and Google announcements. There is likely to be a deferment of investment and hiring plans as companies consider the real outcome of Brexit. Consumer spending is likely fall if the relative weakness in sterling continues and lifts import prices.
Phillip Hammond’s autumn statement announced £3.7bn fiscal support to the economy through government spending on infrastructure such as road, rail, 5G broadband and housing projects in order to boost activity, but it was clear that his concerns over post Brexit growth restricted his ambition. This extra spending is aimed at combatting any slowing of activity over the Brexit period and improving the UK’s poor productivity levels. The OBR has ‘pessimistically’ estimated that Brexit could cost the UK £58bn in lost economic growth. The Chancellor will need to borrow to cover this lost revenue so adding to the UK’s already massive national debt which currently stands at £1.725tn and costs us £60bn pa in interest payments.
The jobless rate fell to 4.8% while the total number of people in work was at a record high of 31.8 million.