Brexit was so 2016


Two years after the Brexit referendum, stunningly little progress has been made in executing the withdrawal. That lack of progress has in turn led to a lack of clarity on the part of UK firms. While measures of business sentiment initially took a hit in the wake of the vote, real economic activity remained solid through mid-2017 – so much so that the Bank of England was willing to reverse their post-Brexit rate cut late last year. However, without a clear roadmap, businesses, consumers, and workers would eventually take steps to mitigate their risks.

As the global economy gained steam in Q2 through Q4 last year in a more synchronized fashion, the UK seemed to be only major economy that was getting left behind. Firms have opening offices and shifted workers into the EU, real estate prices are under pressure, and the initial competitive boost of sterling weakness has faded as the currency stabilized. Two years in, the economic fall-out of the referendum is clearly being felt. Moreover, with only a provisional agreement on the transition period, and virtually no progress on other important issues like financial services or the Irish border, the UK is at risk of stagnating even further.

While the journey toward withdrawal remains in progress, some clear lessons have emerged in the negotiating process that might help Britain in the latter stages – or at least serve as a cautionary tale to the remaining EU members contemplating life outside the union. One, have a clear objective entering the process. Throughout the negotiation, the UK goals have vacillated too frequently between getting a good deal, avoiding a bad deal, or a compromise withdrawal deal that might have rendered the vote meaningless. To paraphrase Seneca, no wind is favorable if you don’t know which port you’re sailing to. Two, present a unified front.

Undoubtedly, the UK’s position in these negotiations has been weakened by infighting: Leave vs. Remain, Tory vs. Labor, Tory vs. Tory, Lords vs. Commons. Prime Minister May has been fighting with both hands tied. Third, know your line-in-the-sand. Without a real willingness to walk away, you have little credibility in the eyes of your counterparty. Hard Brexiteers were willing to accept those painful consequences (and may still get the chance), but constant backsliding by the UK has emboldened EU negotiators. The UK’s unclear withdrawal strategy has created uncertainty, and that uncertainty ultimately has real downside economic consequences.

Philippe Waechter, Chief Economist, Ostrum Asset Management

The most striking impact of the Brexit is the lower growth momentum seen in the UK since the referendum. The dynamics has faltered and the UK has not taken advantage of the strong growth improvement of the Euro Area in 2017.

A very simple calculation can translate this remark. I have calculated a trend on the real GDP level from the beginning of the recovery in 2013 to the second quarter of 2016 (referendum) and extended it to the first quarter of 2018. I did the same for France, Germany and the Euro Area. In the first quarter of 2018, the French GDP is 1.8% above its trend, Germany is +1% and the Euro Area +1.4% while the UK is 2% below it.

GDP - Deviation from the 2013-2Q 2016 Trend

The UK is disconnected from the rest of Europe while the Euro Area is its main trade partner. In other words, despite the European recovery there was no positive contagion to the UK.

Expectations about the UK have dramatically changed and the domestic market is not strong enough to drive a strong growth trajectory. The uncertainty will remain, implying less capital inflows, people outflows leading to lower human capital and lower capital expenditures. The adjustment process is just at its beginning.

It means that the Bank of England will not rapidly normalize its monetary policy. The inflation rate is converging to the BoE target at 2% and the economic momentum is low. Taking the risk of a normalization would be another source of weakness for the UK.

The main effort is to reduce uncertainty for everyone, from households to companies and foreign investors. That would be key for a recovery. But the current negotiation with the European Commission and the weakness of Theresa May and her Parliament do not remove the risk of a hard Brexit and a situation that would have a persistent negative impact on the UK economy.

By Dave Lafferty, Chief Market Strategist

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