The UK economy has performed exceptionally well in the past years, even after the Brexit referendum. So well, that international agencies such as the IMF or the OECD had to completely reverse their negative expectations for the economy of a “Yes” vote.
The problem is that we have focused on the positive -the fact that doomsayers were wrong- without analysing the negatives -the impact on potential growth and increase in investments-. The Bank Of England had to increase its growth estimates for 2017 to 1.7% and 1.3% for 2018. However, the uncertainty of a hung parliament, a weak government unable to negotiate Brexit from a position of strength, and the ongoing weakness of the pound may continue to erode growth potential, gross capital formation and economic agents’ investment and hiring decisions.
It is extremely unlikely that Brexit will be reversed. It is, however, very likely, that negotiations will be more difficult and longer.
The UK is a very dynamic economy, and its companies have enormous strengths, with a thriving export sector and global multinationals. These will continue to benefit from a weak currency, but internal demand and the large surplus of service exports may suffer from the uncertain process of an even more complex Brexit.
As such, it is likely that we will not see a major impact in the growth prospects of the economy due to the benefits of a global and strong external sector, which benefits more from solid high-margin products and competitive technology than from weak currencies, but internal demand challenges will likely have an impact on consumption, hiring and wages.
It is no surprise, then, that the FTSE will continue to rise. It is fundamentally composed of diversified international companies. The impact of uncertainty may weigh on banks, consumer stocks and those with a large proportion of sales in the UK. However, the FTSE is more impacted by estimates of the global economy and energy-commodity prices. It is an index with almost 30% of sales in foreign currency.
The pound weakness may continue, also because the BoE is unlikely to take any measures to defend the currency.
As for bonds, extended QE means that sovereign bond yields will remain depressed, while solid corporate earnings and good balance sheets will support a more than adequate demand for corporate bonds. A clear indicator this morning is that yields are still very contained in all the different indices.
Clearly, investors will have to pay attention to guidance and cash flow generation of companies, but I would imagine that the forthcoming uncertainty will likely have an impact on a potential growth that should be well above EU or US figures, but will not.
Being complacent about average growth and acceptable macro figures cannot disguise the fact that the UK could and should grow well above its comparable economies and that the Bank of England is keeping an uncomfortably aggressive quantitative easing program that will leave it without tools in case of a change of economic cycle that is now more likely than before. | Daniel Lacalle | Friday, June 9, 2017
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Daniel Lacalle has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)
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