Tag Archives: EU Referendum

UK economy post referendum – for richer, but mostly for poorer

We may well never know the true extent of the impact of the EU referendum outcome on the British economy, markets and ultimately standards of living. This may not be the most satisfying conclusion, but this uncertainty is one which policy-makers will have to grapple with.

As to the bigger question of whether the UK is better off today or will be better off in years to come when one takes into account not only the impact on the economy but also broader, less tangible issues such as sovereignty, the answer is and will likely remain even more subjective.

In any case, available data paint a patchy picture of the UK economy post-referendum. Construction and services have been harder hit than manufacturing. Retail sales were strong in July thanks in part to a robust labour market and plentiful lending. While this defies the collapse in consumer confidence temporary factors may also have been at play.

The residential property market at a national level has been softer but resilient post referendum. Mortgage lending remains depressed but government policies are for now more likely to blame. The commercial property market has been harder hit.

Sterling’s 10% collapse since the referendum, following a 10% depreciation between November and June, is seemingly supporting economic growth and demand for UK assets even if history suggests that it is no panacea. Its inflationary impact has so far been very modest but the risk is a squeeze on profit margins and real wages.

At the same time sterling’s collapse has tangibly eroded the UK’s net wealth, at least when expressed in foreign-currency terms – a fact largely ignored by policy-makers and the media.

I would expect the BoE to continue favouring monetary and credit policies which explicitly help spur lending, spending and investment and, implicitly at least, help cap sterling. While this may not translate into another policy rate cut or round of QE near-term, the BoE is likely to keep this option firmly on the table if the UK economy fails to return to trend in the next six months.

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Post Referendum Circular Reference

It has been a fortnight since the UK electorate voted to leave the EU and the British political and financial landscape has already changed dramatically. But what we don’t know or can only tentatively forecast still dwarfs what we know.

The referendum result simply reflected a popular preference for the UK to leave an international organisation, nothing less, nothing more. There is no precedent for UK and EU leaders to rely on and Article 50 is at best only a very skinny rule book.

For all intents and purposes UK and EU leaders are flying blind. It’s not even obvious who is at the controls, let alone who will lead negotiations on behalf of the EU and in particular the UK following seismic changes in political personnel.

The next steps are thus anything but straightforward and the UK government and EU are currently caught in a prisoner’s dilemma, with none of the key players seemingly willing to make the first move.

The referendum result is not legally-binding, only advisory, and therefore the Lower House of Parliament will likely have to vote on whether to trigger Article 50. But the British government has so far provided only a vague wishlist and simply doesn’t know what the EU may or may not agree to.

Parliament will not want to kick start an almost irreversible process whereby the UK has announced a divorce but doesn’t know the terms and conditions of this divorce, let alone what its new relationship will look like. Unsurprisingly, the British government is playing for time.

But EU leaders have suggested that discussions about the UK’s exit from the EU and future trade agreements were conditional on the UK government first triggering Article 50. And that takes us back to square one.

When this deadlock is broken will depend on many variables, including the length of the stalemate itself, who is in charge at the point of making a decision and the ability and willingness of negotiating parties with different vested interests to compromise.

I would argue that the longer this stalemate lasts, the greater the likely damage to the UK and EU economies and the greater the odds that Article 50 is not triggered in the first place or that a mutually satisfactory deal is eventually reached. Early British general elections cannot be discounted, nor can a second referendum in a more extreme scenario.

Assuming that the current circular reference paralysing EU and UK leaders is unbroken near-term, the associated uncertainty will likely continue to weigh on the UK economy, sterling and global risk appetite. Whether this morphs into a deeper and more widespread crisis may boil down to how patient global financial markets are willing to be. Read more

Brexit: More questions than answers

The UK, the world and financial markets have now had five days to digest the British electorate’s vote to leave the EU and its impact on UK and global asset prices.

So far Sterling and Japanese and European equity markets have borne the brunt of the initial shock, while the FTSE is down only 3.3% since Thursday and most major and emerging market currencies have been reasonably well behaved (see Figure 1).

But there are still far many more questions than answers and the situation remains extremely fluid.

For starters there is no precedent for a country leaving the EU and thus no clear-cut rulebook to rely on. The government has limited institutional capacity to start negotiations with the UK’s 27 EU partners until Article 50 of the Lisbon Treaty is triggered and no timeline has been provided for when this will happen (assuming it is triggered at all).

Perhaps unsurprisingly given the mammoth task ahead, the Leave campaign leaders have been very short on specifics regarding the mechanics and timing of the UK’s exit from the EU, the likely shape of future trade treaties and national policies such as immigration. Prime Minister Cameron’s de-facto resignation and wholesale changes in personnel in the opposition Labour Party are adding to the head-scratching.

Moreover, it is not one country seeking to leave the EU, but a union of four countries – England, Wales, Scotland and Northern Ireland – which further complicates matters as both Scotland and Northern Ireland seem intent on remaining part of the EU and potentially breaking free from the UK.

At this point in time, all we can do is take stock of what we know (or at least we think we know) and what we don’t know (but can tentatively try to forecast).

I would conclude, as I did in Europe – the Final Countdown (21 June 2016), that the many layers of political, legal, economic and financial uncertainty are likely to keep UK investment, consumption and employment, as well as Sterling on the back-foot for months to come. Financial market volatility is also likely to remain elevated in coming weeks.

In this context the US Federal Reserve is likely to keep rates on hold in coming months and the European Central Bank can probably afford to do little for the time being. The Bank of England is likely to seriously contemplate cutting its policy rate while the Bank of Japan will be under renewed pressure to curb soaring Yen strength.

Of course, British policy-makers and business associations have come out and said the right things in order to limit the carnage and contagion. But they have far more limited room to reflate the economy and fade gyrations in financial markets than they did during the 2008-2009 great financial crisis. They are not in control at this juncture and it is not obvious who is.

 

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UK referendum: Blame the weather, not Brussels

The outcome of today’s crucial UK referendum on EU membership will partly depend on how many of the 46.5 million registered voters cast their postal votes and turn up today at voting booths which opened at 07.00 (UK time) and will close at 22:00.

Opinions polls have concluded that a lower voter turnout today would favour the Leave vote while a higher turnout would favour the Remain vote. 

But intentions to vote are not the same as actually ticking the ballot box. Bad weather is more likely to keep people at home and turnout low, favouring the Leave vote while dry weather would in theory encourage people to vote, in turn favouring the Remain camp.

There have so far today been scattered showers across the UK and the Met Office has issued an amber weather warning for the East of England, London and South-East England, with predictions of thundery showers throughout the day.

However, the Financial Times is reporting that in many parts of London there are long queues at several polling stations and the Met Office is forecasting largely dry and cloudy weather elsewhere in the UK.

It is somewhat ironic that the unpredictable British weather, a favourite topic of conversation, could potentially change the British economic landscape for years to come.

The consensus expectation is that if the UK votes to remain in the EU, sterling, UK equities and to an extent the euro and global equities will rally sharply. But this rally could start to fade after a few days, as markets refocus on global data and events and the British turn their attention to the all-important matter of the Euro 2016 championships and perennial question of whether Andy Murray can win a second Wimbledon title.  

But acute uncertainty and market volatility would likely persist for weeks and potentially months should the leave camp win today’s referendum, particularly if it wins by only a very narrow margin and/or turnout is low. Read more

Europe: The Final Countdown

On Thursday 23rd June, the British electorate will hold arguably the most important vote in a generation, with the result of the UK referendum on EU membership due to be announced on Friday.

The latest opinion polls have the remain camp slightly ahead and bookmakers attribute a 75% probability of the UK voting to stay in the EU. But caution is warranted as opinion polls have swung back and forth in recent weeks. Turnout, and therefore the weather, may be a critical factor with a high turnout likely to favour the leave vote.

I am nevertheless sticking to my long-held view that the British electorate will vote for continuity and for the UK remain in the EU.

The popular assumption is that after the referendum UK markets and global risk appetite will move in clear directions. This belief is likely to be tested, particularly if the British electorate votes in favour of brexit as the government is not legally bound to the referendum result.

Specifically, the consensus expectation – which I share to a degree – is that if the UK votes to remain in the EU, sterling, UK equities and to an extent the euro and global equities will rally sharply. But this rally could start to fade after a few days, with “business-as-usual” resuming.

Conversely, the over-riding view is that sterling and global risk appetite will weaken, potentially very sharply, in the days following a vote for the UK to leave the EU.

Importantly I see six potential sources of uncertainty and a number of possible scenarios (see Figure 6), particularly if the leave camp wins by only a very narrow margin and/or turnout is low.  Market volatility could thus persist for weeks and potentially months, keeping sterling and UK equities on the back foot:

  1. Prime Minister Cameron’s future;
  2. The risk of the British government ignoring the referendum result;
  3. The risk of the British parliament ignoring the referendum vote, the government re-negotiating a deal on the UK’s membership to the EU and holding another referendum;
  4. The risk of a second Scottish independence referendum;
  5. The risk of a protracted UK exit from the EU leaving the door open to a decision reversal; and
  6. The re-negotiation of new trade treaties.

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EU Referendum survey results: UK will very likely remain in EU and sterling may appreciate

75% of 130 analysts, consultants, journalists, finance specialists, real-sector heads, policy-makers and portfolio managers forecast that the UK electorate will vote in favour of the UK remaining in the European Union (EU) in the 23rd June referendum, in a survey which I conducted between the 10th and 16th May. That ratio jumps to 81% when the 10 respondents who did not have a view are excluded.

By comparison, the latest poll-of-polls conducted by What UK Thinks has the “remain” vote on 52% and “leave” vote on 48% five weeks before this crucial vote. But caution is warranted given the large share of undecided voters, the importance of turnout and differing results depending on whether polls are by phone or on-line. Current prices offered by betting companies suggest a comfortable victory for the “remain” vote.

Of the 130 respondents with a view which I surveyed, 65% forecast that the UK leaving the EU would be negative for the British economy medium-term. 19% forecast that it would be positive and 15% that it would be neutral[1]. This is broadly in line with the view expressed by Prime Minister Cameron and “remain” camp, the Bank of England and IMF.

The risk to the currency is forecast to be somewhat asymmetric. There is an overwhelming view amongst those surveyed that, if the UK leaves the EU, sterling will depreciate while 38% forecast sterling to depreciate or remain stable should the UK remain in the EU.

Specifically, out of 131 respondents, 81% forecast that if the electorate votes for the UK to leave the EU, sterling would depreciate between the referendum and end-year against the currencies of the UK’s key competitors. Only 8% forecast that sterling would appreciate, while 6% thought that the currency would be broadly stable. 6% did not express a view.

But out of 127 respondents, only 54% forecast that if the UK remains in the EU sterling would appreciate. 11% forecast that sterling would depreciate, while 27% thought the currency would be broadly stable. 8% did not express a view.

These survey results tend to back my view, expressed in What to expect in 2016 – same, same but worse, that the electorate will vote for the UK to remain in the EU and that the lifting of this uncertainty will see a reasonably competitive sterling appreciate.

But any currency rally is likely to be moderate given the UK’s structural deficiencies, including a large current account deficit, low productivity and weak wage growth, and a dovish central bank. A “remain” vote will not address these vulnerabilities near-term.

Finally, a note of caution. Like all polls, this survey may contain unintended biases which are difficult to ascertain let alone measure accurately.

The survey consisted of four sets of questions and was open from 10th May 2016 (12:00) to 16th May 2016 (12:00). Respondents could chose to skip one or more questions. I would like to thank the 131 analysts, consultants, journalists, finance specialists, real-sector heads, policy-makers, portfolio managers, sell-side salespeople, strategists and traders who responded to this survey.

 

Broad consensus forecast that UK will remain in the EU

Question 1: How do you expect the UK electorate to vote in the 23rd June 2016 referendum on EU membership?

75% of the 130 respondents surveyed forecast that the UK electorate will vote in favour of the UK remaining in the European Union in the 23rd June referendum (see Figure 1). That ratio jumps to 81% when the 10 respondents who did not have a view are excluded.

Olivier Desbarres EU survey q1 results

Popular opinion polls have “remain” marginally ahead of “leave” but many caveats

By comparison, the latest poll-of-polls conducted by What UK Thinks, which averages the results of the last six phone and on-line opinion polls, has the “remain” vote on 52% and “leave” vote on 48% (Figure 2)[2]. The “leave” vote has only been ahead of the “remain” vote once since September and has on averaged trailed the “remain” vote by about 4.2 percentage points (see Figure 3).

Olivier Desbarres referendum results

But caution is warranted, due amongst other factors to i) the large share of undecided voters, ii) the importance of turnout, and iii) the difference in results between online and phone surveys.

The Daily Telegraph estimates that in the 100 EU referendum polls conducted since early September, undecided voters accounted on average for 15%. While assumptions can be made about how they will ultimately vote on referendum day, these undecided voters could swing the outcome either way.

Moreover, turnout may influence the referendum’s outcome with those who support the “leave” camp more likely to definitely vote according to ORB. In its last poll conducted on 11-15th May, ORB found that 53% of respondents would vote “remain” – an increase of 2 percentage points from a poll conducted on 20-24th April – and 39% backed “leave” – a 4 percentage point decrease. But this large gap shrinks considerably if we take into account that 53% of “remain” voters and 62% of “leave” voters said they would definitely vote. If only those voters are included, support for “remain” falls to 51% while support for “leave” rises to 45% (see Figure 4).

Olivier Desbarres - EU survey results fig 4

Finally, since the start of September, phone polls suggest an average 17 percentage point lead for “remain” while online polls have it at just 2 percentage points according to the Daily Telegraph[3].  In the latest ICM poll conducted on 13-15th May, the phone poll had the “remain” vote comfortably ahead of the “leave” vote but the online poll had the “leave” vote slightly ahead (see Figure 5).

Olivier Desbarres EU survey results fig 5

Betting companies’ pricing points to comfortable “remain” victory

The inherent limitations of opinion polls were made evident in the 2015 general elections, with none of the polls predicting the incumbent Conservative Party’s comfortable victory. As a result there has been increasing focus on betting companies’ odds of a “remain” or “leave” victory.

After all, while those polled may have a reason not to declare their true voting intentions, they are more likely to put their money where their mouths are when real financial gains (or losses) are at stake. Prices offered by the main UK bookmakers point to a clear “remain” victory, with odds of 1/4 for the UK to remain in the EU and 11/4 for the UK to leave the EU.

My core scenario remains a victory for “remain” vote

Any forecast of the referendum outcome remains tentative but I maintain my core scenario expressed in What to expect in 2016 – same, same but worse (19 January 2016) that Prime Minister Cameron will secure a “remain” vote, premised on:

  1. The greater domestic support for the “remain” vote from the political and business sphere as well as international community, which will count when campaigning really intensifies in coming weeks.
  1. The UK’s electorate’s conservative nature. The “yes” vote in Scotland’s 2014 referendum on UK membership suggests that the collective desire to be part of a union should not be under-estimated, while the incumbent Conservative Party’s convincing win in the May 2015 elections underlines the electorate’s affinity for continuity, rather than the unknown.

 

Two-thirds of respondents think UK leaving EU would be negative for British economy

Question 2: If the UK electorates votes in favour of the UK leaving the EU, do you think this will be positive, negative or neutral for the British economy medium-term?

65% of the 131 respondents forecast that the UK leaving the EU would be negative for the British economy medium-term. 19% forecast that it would be positive and 15% that it would be neutral. One respondent did not have a view (see Figure 6). This is broadly in line with the assessment presented by Prime Minister Cameron, Chancellor Osborne and the “remain” camp, as well as the Bank of England and International Monetary Fund.

In its latest quarterly inflation report, the Bank of England concluded that “a vote to leave the EU could have material economic effects – on the exchange rate, on demand and on the economy’s supply potential […]. Aggregate demand would also likely fall, relative to our forecast, in the face of tighter financial conditions, lower asset prices, and greater uncertainty about the UK’s trading relationships. Households could defer consumption, and firms could delay investment. Global financial conditions could also tighten, generating potential negative spillovers to foreign activity that, in turn, could dampen demand for UK”.

The IMF, in its latest Article IV Consultation, concluded that if the UK remained in the EU GDP growth would rebound in H2 2016. Conversely, the UK leaving the EU would:

  • Lead to a protracted period of heightened uncertainty and financial market volatility;
  • Substantially depress UK productivity, trade, output, incomes, consumption, investment and fiscal revenues;
  • Potentially weaken UK equity and house prices; and
  • Potentially increase UK borrowing costs for households and businesses and inflation.

Olivier Desbarres - EU survey results fig 6

 

Respondents forecast asymmetric sterling reaction-function

Question 3: If the UK electorate votes in favour of the UK leaving the EU, how do you expect sterling to perform between the referendum and end-year against the currencies of the UK’s key competitors?

Olivier Desbarres EU survey results fig 7

Out of 131 respondents, 81% forecast that if the electorate votes for the UK to leave the EU, sterling would depreciate between the referendum and end-year against the currencies of the UK’s key competitors (see Figure 7). Only 8% forecast that sterling would appreciate, while 6% thought that the currency would be broadly stable. 6% did not express a view. If the 8 respondents who did not have a view are excluded, the percentage of respondents expecting sterling to depreciate rises to 86%.

 

Question 4: If the UK electorate votes in favour of the UK remaining in the EU, how do you expect sterling to perform between the referendum and end-year against the currencies of the UK’s key competitors?

Out of 127 respondents, only 54% forecast that if the UK remains in the EU sterling would appreciate (see Figure 8). 11% forecast that sterling would depreciate, while 27% thought the currency would be broadly stable. 8% did not express a view. If the 10 respondents who did not have a view are excluded, the percentage of respondents expecting sterling to appreciate rises to 59%.

Olivier Desbarres - EU survey results fig 8

Sterling likely to appreciate post referendum if UK votes to remain in EU

These survey results tend to back my view, expressed in What to expect in 2016 – same, same but worse, that the electorate will vote for the UK to remain in the EU and that the lifting of this uncertainty will see a reasonably competitive sterling appreciate.

There has been mounting evidence that domestic and foreign companies have curtailed or delayed investment in the UK, with domestic companies also prone to freezing hiring a as a direct result of the uncertainty associated with the referendum outcome. In UK referendum on EU membership – darkness before dawn (26 February 2016), I highlighted eight layers of uncertainty: 1. How the electorate will vote; 2. The (un)reliability of opinion polls; 3. The lack of political unity; 4. The lack of precedent; 5. The lack of explicit contingency plans; 6. Prime Minister Cameron’s future; 7. The possibility of another Scottish referendum; and 8. The possibility of a second EU referendum if the result on 23rd June is too close to call.

UK gross fixed capital formation, seasonally-adjusted, contracted 1.1% quarter-on-quarter in Q4 2015 – the largest contraction in over three years (see Figure 9). Similarly, business investment shrunk 2% qoq in Q4 2015 – the second largest quarterly contraction in seven years – which wiped out the growth in the previous two quarters. Delayed or curtailed investment has in all likelihood contributed to business and consumer confidence falling to multi-month lows (see Figure 10), which in turn depressed consumer spending, investment and GDP growth in Q1 2016[4] (see Figure 11).

A “remain” victory on 23rd June would remove this uncertainty with a return to the norm and likely unlock delayed or curtailed investments in capital and labour. In the event of a “leave” victory, there would still be a great deal of uncertainty near-term as ultimately there is no precedent for a country leaving the EU and thus no clear-cut rulebook to rely on.

Olivier Desbarres - EU survey results fig 9 and 10

Moreover, the British economy is likely to benefit at the margin from the lagged impact of a more competitive currency even if weak global demand is likely to dull any narrowing of the UK trade deficit. Sterling’s trade weighted index (TWI) has recovered slightly in the past few weeks, but is still down 9% from its seven-and-a-half-year high recorded nine months ago according to my estimates (see Figure 12).

Olivier Desbarres - EU survey results fig 1112

Finally, sterling’s depreciation should, all other things being equal, have an inflationary impact (as the sterling-cost of imports rises). This may be sufficient for the Bank of England to communicate a less dovish, if not more hawkish, policy stance even if core inflation, which has been running at 1.2-1.5% year-on-year, is unlikely to become an issue in the near-term.

 

Post-referendum rally likely blunted by underlying UK imbalances and dovish central bank

However, any currency rally is likely to be moderate until the government addresses structural deficiencies, including a large current account deficit, low productivity, still-high levels of household debt and fiscal deficits and weak wage growth, and the Bank of England turns more hawkish. The fact that survey respondents are less confident about sterling appreciating in a “remain” scenario than they are about sterling depreciating in a “leave” scenario may indeed be due to these underlying weaknesses which a “remain” vote will not fully address.

Specifically, the UK is running a record-high current account deficit (see Figure 13), as a result of a widening of the goods and services trade deficit, a decrease in receipts from direct investment and portfolio investment abroad and an increase in payments to foreign direct investors.

At the same time the Bank of England is showing no sign of wanting to hike its record-low policy rate of 0.5%, in the face of tepid wage and consumer price inflation. While the UK unemployment rate has been stable near a record-low of 5.1% since October, growth in real earnings (including bonuses) has slowed sharply in recent months, suggesting there is still a fair degree of slack in the UK labour market (see Figure 14). This is likely contributing to modest core-inflation which fell to 1.2% year-on-year in April and remains steady around its 2-year average.

Olivier Desbarres - EU survey results fig 1314

 

Olivier Desbarres

Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He has over 15 years’ experience with two of the world’s largest investment banks as an emerging markets economist, rates and currency strategist.

 

[1] Total may not add up to 100% due to rounding

[2] The question posed is the one approved by the Electoral Commission for the actual referendum: “Should the United Kingdom remain a member of the European Union or leave the European Union?”

[3] As there have been three times as many online polls as phone polls, the weighted average of the difference between the “remain” and “leave” votes is skewered towards the online poll results.

[4] A breakdown of Q1 2016 GDP is due for release on 26th May