Global stock markets have found their rhythm following the initial sell-off after the UK referendum to leave the European Union. The MSCI World index is up nearly 9.5 per cent and FTSE 100 15.5 per cent.
While the UK faces a period of uncertainty ahead as it seems that the government will not invoke Article 50, which allows a member state to withdraw from the EU, before the new year, its effects on asset prices, economic activity as well as broader geopolitics are starting to emerge.
Recent economic data has been, in fact, better than consensus expectations, although the picture remains mixed.
Last month’s manufacturing and services PMI were much stronger than expected and showed a return to expansion, however, they were probably overstated after an extremely weak print in July. Industrial production, too, was higher than consensus and prior readings.
But the numbers were mainly driven by mining and quarrying, sectors that were supported by the rise in oil and gas prices. In fact, UK manufacturing production fell by 0.9 per cent month over month, which seems to back the expectation that growth will slow in the coming months. Retail sales dropped by 0.2 per cent last month and this reduction followed a strong jump of 1.9 per cent in July. Some surveys show a much greater fall, so a revision down could be expected.
Commercial property has been at the forefront of the initial fallout from Brexit, with transaction volumes slowing materially and values, notably at the top of London property, beginning to fall.
Further weakness is expected as businesses, domestic and foreign, delay capital expenditure until further clarity is achieved.
The residential housing sector has already experienced a slowdown with contractions in volumes, home prices and mortgage approvals.
The Halifax index of house prices fell by only 0.2 per cent last month, although the index’s three-month average of yearly growth declined from 8.4 per cent in July to 6.9 per cent in August. This will be watched closely as a good guide to prevailing sentiment.
At the beginning of last month, the Bank of England’s (BoE) Monetary Policy Committee passed a package to support growth. This included a 0.25 per cent cut to the official interest rate bringing it down to 0.25 per cent, alongside further quantitative easing and a new corporate bond purchase programme. The BoE also meaningfully revised down its GDP forecast for next year. The estimate was taken down to 0.8 per cent from 2.3 per cent in May, showing the BoE’s outlook has become more negative following the Brexit referendum. At its latest meeting on September 15, the BoE announced it now expects less of a slowing in GDP growth in the second half of 2016 and made no further monetary policy changes.
Recently released numbers show that UK inflation has remained stable in August. Year over year growth in headline inflation was 0.6 per cent, the same as July but below the 0.7 per cent consensus estimate.
However, the Monetary Policy Committee estimates inflation for the third quarter of this year to be higher, at 0.8 per cent, and there are also some signs that retailers will be passing on to consumers price increases as an effect of sterling’s strong depreciation after the vote to leave the EU.
Following the referendum vote, the pound has weakened by more than 12 per cent against the US dollar. While this has affected many businesses for which import prices have risen, a weaker currency is positive for British exporters as it makes the cost of their goods more competitive abroad – and it should lift their overseas earnings. This has been reflected in a strong rise in many FTSE 100 companies’ share prices.
As businesses experience a rise in input prices and observe slower growth prospects, they will most likely be moderating their capital expenditure and hiring plans. Wage growth is almost surely going to be negatively affected.
With no personal income growth and prices eventually rising, consumer confidence is set to be challenged and a deterioration would not be a surprise.
While, in the near term, the economy is surprising expectations by proving to be quite resilient, the consequences of the UK referendum will take time to unfold and it seems likely the UK macroeconomic environment will gradually deteriorate in the medium term.
Aside from the immediate impact to economic growth, the outcome of the UK referendum has broader ramifications on the political front. With populist parties spreading across Europe, political contagion remains a risk. Whether a coincidence or not, following the UK’s decision to leave and the subsequent resiliency of European growth, opinion polls have shown an increase in the popularity of Eurosceptic parties across a number of countries. An upcoming Italian referendum this year, followed by elections in France, Holland and Germany next year present clear dangers.
These fears are well known by investors, hence the 30 weeks of straight outflows from European equity funds. While the risks are real, should the negativity towards European assets persist it will only serve to present investment opportunities for investors.
Tony Lanning is a managing director and senior portfolio manager and Ilaria Calabresi is a vice president at JP Morgan Private Bank.
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