The Economic Fall-out of Brexit

The Economic Fall-out of Brexit


Brexit, as of now, is a reality in the truest sense of the term with the triggering of Art. 50. Brexit, it seems, has not caused a predicted slump in economic activity, at least not to a great extent.

At the same time, however, it does not indicate any great expansion of economic activity.The economic data available is only that of the last quarter of the previous calendar year. So, an analysis of its full impact in this new year and after the triggering of Art. 50 is not very illuminating. Moreover, the economic data of the 4th quarter of 2016 along with other forecasts may offer a considerable degree of insight.

Britain’s GDP increased by 0.7% in Q4 of FY’16, up from 0.6% in the previous quarter. The BBC states that this is mainly due to the manufacturing industry having done better than expected. This uptick in manufacturing indicates the positive impact that Brexit has had in terms of inducing inflation.

It was known that Brexit would cause inflation in the UK economy. Inflation, as it stands now at 2.3%, is healthy and necessary to give impetus to production and the GDP growth evidences that. Another major reason for this GDP growth is increased consumer spending. In  Q4  of FY’16, real household spending per head increased 0.5% compared with the previous quarter– despite a fall in real household disposable income of 0.1% over the same period – meaning that it reached its pre-economic downturn level for the first time. 

However, this spurt in GDP is not one that can be predicted to continue. The Office of National Statistics has revised its estimate of the GDP for the FY’16 from 2% to 1.8%. Furthermore, according to a report by PWC, the UK’s growth may slow down to 1.6% in FY’17 and 1.4% in FY’18. The reason for this is two-fold.

Firstly, a decrease in consumer spending can be expected due to decreased consumer confidence and inflation. In fact, “between Quarter 3 2016 and Quarter 4 2016, consumers reported a worsening in their perception of both the general economic situation and their own financial situation over the last year,” according to the Office of National Statistics(ONS). PWC forecasts consumer spending to go down to 2% in FY’17 and 1.8% in FY’18.

Secondly, the uncertainty created in business environments due to the changing political landscape can be expected to cause the predicted slump in growth. The impact of this uncertainty is already visible. According to the ONS, business investment fell by 1% in Q4 2016 when compared with Q3 of 2016.

The economic sector which has taken the biggest hit is the services sector. The services sector makes up about three-fourths of the UK economy. According to the BBC, “the Markit/CIPS purchasing managers' index (PMI) for services fell to 53.3, down from 54.5 in January.” However, it remains above the 50 threshold that separates growth from contraction.

The service sector loses the advantages of common market provided by the EU and without new deals for investment in other countries, the UK economy shall take a hit when the Brexit process is completed. In addition to this, the weakening of the pound makes the picture look even more bleak.

According to the BBC, “the pound fell dramatically after the Brexit vote last year, and since then has been trading around 15% lower compared to the dollar and 12% lower compared to the euro than it was before the referendum.”

This implies that UK companies and financial service providers need to spend more in order to invest in economies. An increase in investment expenditure which does not lead to a rise in the amount invested due to weakening of the exchange rate impacts these businesses very negatively.

The combined effect of decreasing growth and inflation cannot be under-estimated. As Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said, "We continue to expect quarter-on-quarter GDP growth to average just 0.2% this year, ensuring that the [Bank of England's Monetary Policy Committee] holds back from raising interest rates despite high inflation."

The combination of lower growth with higher expected inflation could herald a period of "stagflation", he added. Rising rates would decrease liquidity in the economy whilst reducing  consumer spending.The combined effect of both these changes would insinuate a ‘stagflation’ and a contraction of economic activity. Although, a rise in interest rates is unlikely at this point in time, but the Bank of England may raise them from the present 0.25% if faced with higher inflation in the future.

The weakening of the pound has been instrumental in impacting the massive trade deficit. UK exports and imports both rose in January - by £400m and £300m respectively - leaving the trade deficit in goods and services steady and unchanged from December 2016 at £2.0bn, the ONS said.

However, the ONS also said that in 2016, excluding oil and other erratic commodities (such as ships, aircraft, precious stones, silver and non-monetary gold), the underlying trend in trade in goods was a widening of the deficit. The UK does sell more services abroad than are imported - but this is not enough to counter the bigger deficit in the value of the goods sold abroad, compared with the value of the goods imported.

Financial Markets have cheered Brexit. The FTSE 100(The London Stock exchange’s index) has grown about 16% since the referendum, according to the BBC. A similar picture was observable in the FTSE 250, an index of the shares of mainly domestic companies, which has grown 11%. However, the FTSE 100 has taken a slight hit after the election announcement by May and a slump in the stock prices of Barclays.

The slump in Barclays share prices was due to its investment banking department’s underperformance and even a doubling of the bank’s profits in Q1 of FY’17 was not enough to increase investor confidence in the bank. The FTSE 100 closed at 7203 GBP after registering an intra-day decrease of around 0.5% on 28th April, 2017.

The decrease in Barclays stock prices is not isolated, the stock prices of banks like Standard Chartered have also slumped by 20%. This goes to show that decreasing investor confidence and the hit taken by the services sector are both affecting the UK economy in a substantial way. 

Brexit exposes certain inherent weaknesses of the UK economy. According to Charles Giles of the Financial Times, “The UK neither has US-style low taxes nor Germany’s level of public services.” Brexit shows that Britain’s economy lacks productivity.

Britain’s largest sector- the services sector will be deprived of the advantages that the common market provides due to Brexit. The full impact of Brexit, however, remains to be seen and much will turn on how Britain redefines its relationship with the EU and the rest of the world.

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