Brexit Update: How Bad Will It Be?
Brexit will be bad, because Theresa May thinks so. A leaked recording of her talking to Goldman Sachs in May 2016 shows that she thinks there are “benefits” for the economy and security if the UK remains in the EU.
In the recording, she says “being part of a 500 million population trading bloc is significant for us. I think one of the issues is that a lot of people will invest here in the UK because it is the UK in Europe.” She also adds that “if we were not in Europe, I think there would be firms and companies” which will seek to secure “a mainland Europe presence rather than a UK presence.”
So, when Mark Carney says that Sterling’s drop is due to: a) May saying that she will trigger Article 50 in March 2019, and b) how the market understands the UK-EU relationship, then the economy is and will be affected by Brexit. Everything that has to do with Brexit sends shock waves through the market.
Mark Carney and the BoE
The Bank of England (BoE) Governor was questioned on Tuesday, 25 October, by the House of Lords Economic Affairs Committee about the economic consequences of the vote to leave the EU. Carney’s contract with the BoE expires in the summer of 2018, but after criticisms from Theresa May and others, he might reconsider his options.
The role of the Economic Affairs Committee is to examine economic issues. The committee reports to the House of Lords with suggestions which can lead to government action. The published report includes evidence, the committee’s findings and its recommendations to the Government. It consists of thirteen members. The chairman is Labour party’s Lord Hollick and the 12 Lords are Conservative, Labour, Liberal Democrat or Crossbench members.
What do we know so far about the state of the UK economy?
• The pound has been dropping after the vote and remains at $1.21. Two events moved the pound to its lowest levels and those were “a flash crash,” believed to be caused by a computer programmed to make automatic trades, and Theresa May’s talk of a hard Brexit at the Tory conference.
• The lower pound is having a negative effect on imports because they have increased disproportionately to exports. There was 5.1% rise in EU imports that increased the trade deficit to £8.4bn. Instead of selling more to the EU and increasing its income, the UK increased the outflow of money by buying more products from the bloc.
• Higher inflation: Inflation rose to 1% in September due to the increase in the prices of clothing, fuel and hotel rooms.
• While construction, manufacturing and services have performed better than expected, according to the Markit/CIPS Purchasing Managers’ Indices, official data shows that growth will slow down because of the rising trade deficit and a decreasing activity in construction and industrial production.
• Public finances saw a decline as government spending was on the rise, income from taxes was lower, and borrowing higher.
• Low wage growth: While the labour market was in good condition with many people employed, pay growth fell. As inflation rises and prices increase, living standards might deteriorate.
• UK retail sales also dropped. Higher prices and the good weather didn’t encourage shoppers to indulge in buying autumnal fashions.
• House prices rose after the shock of Brexit.
Economic Affairs Committee Report
As everyone awaited Carney’s testimony, the pound dropped suddenly to $1.2117 and continued falling to $1.2082. Foreign exchange analysts were predicting that a further drop in the pound might be noticed during and after Carney’s report. Chancellor Philip Hammond’s earlier comments were also possibly driving the pound downwards. Hammond left the possibility of more Quantitative Easing (QE) open and warned that EU leaders will be looking at political and economic issues when discussing Brexit. This seemed to plunder the pound to lows last seen since the “flash crash.”
Mark Carney touched upon the following issues:
• Monetary Policy and QE: Carney defended QE by saying that jobs have been created and economy has grown.
• Change inflation to help savers: This can’t be done because it doesn’t help the wider range of people.
• Interest rates being low: He feels for savers and understands that having very low interest rates for such a long time is very frustrating.
• Will you stay or go? Asked whether he is staying or not, he stressed that it’s a very “personal decision” and he needs “time to reflect”.
• When does Sterling move? Carney answered that it isn’t monetary policy that influences the pound but news relating to the EU’s future relationship with the UK, particularly, May’s triggering of Article 50.
• He admitted that banks are ready to relocate out of London if need be, and some are in the position to adjust their activities in the coming year, all depending on how things develop. He said: “Yes some business would migrate, but City will grow other business from elsewhere.”
• In terms of inflation increasing due to the low pound, Carney said “Relatively quickly we will see the effects of the sterling depreciation. By the spring [inflation will be] 1.5% to 1.8% annualised with an important contribution [from currency].” He also added that “if exchange rate has depreciated and UK supply capacity is weakened by Brexit, it will push up inflation.” Since the date for triggering Article 50 has been made public, the market has become more sensitive.
More bad news: In the next five years, the UK will need to borrow £84 billion, warned the Resolution Foundation thinktank on Wednesday, 26 Oct. Spending more money for the UK’s exit from the EU would leave the Treasury with a loss in every year until 2020-21. This means that the government will need to find savings or borrow money that will amount to more than £80 billion.
This of course, puts investments on hold since there isn’t a clear image of how the UK will deal with Brexit negotiations. A fall in investments, higher inflation and higher unemployment will slow down growth.
If this happens, what seemed like an innocent Leave vote, will turn out to be the worst decision ever.