New government and new fundamentals: Brexit to put a break on UK’s economic growth

The UK has to be prepared for the next couple of years, as Brexit will put a break on the economic growth, so it is time for the new government to focus on the new fundamentals.

According to the latest Confederation for British Industry (CBI) economic forecast, the UK is expected to see subdued economic growth over the next two years.

“Very little has changed in our view of the nature of the outlook. Growth will be slower in the years ahead as living standards are hit by rising inflation; and after some initial strength, uncertainty will weigh on business investment. But with the pound still low and expected to remain so, we do expect more of a lift from net exports.” said Rain Newton-Smith, CBI Chief Economist.

It has already started: after a strong performance in the second semester of last year, growth slowed in the first quarter of 2017 and a slower pace of growth is expected to persist. The economy continues to face uncertainty amid the start of negotiations for Brexit, which will need careful “shipping” by the Government in the months ahead.

The UK’s leading business group, which represents over 190,000 UK businesses, is now forecasting 1.6% growth for 2017 and 1.4% in 2018 compared with the previous forecast of 1.3% and 1.1% respectively. The group expects less support from household spending, with growth slowing in 2017 (from 2.8% in 2016 to 1.7%) and 2018 (to 0.7%). Real earnings are expected to stagnate due to rising inflation.

As for the inflation, it is expected to rise further, with higher outturns pushing up CBI forecast, such that they now expect the CPI rate to peak at 3% towards the end of 2017 (against 2.4% previously). CPI expects inflation to ease a little in 2018, settling at around 2.7%—but, it will remain above the Bank of England’s 2% target for the duration of the forecast.

Business investment is expected to hold up over the near-term, with uncertainty still holding back larger spending projects.

“People are already starting to feel the pinch”

“The UK economy has proved hardy in recent times, with firms up and down the UK getting on with what they do best by investing and creating jobs. Growth should be steady, if restrained, over the next couple of years as the pace of the economy shifts down a gear.” said Carolyn Fairbairn, CBI Director-General.

“While the country’s exporters should emerge as a real catalyst of growth, rising inflation and stubbornly low wage growth mean that people are already starting to feel the pinch. Tighter purse strings mean slower household spending growth and uncertainty is likely to weigh on the minds of those making major investment decisions.” she added.

The CBI representative pointed out that this is the time for a renewed focus on the economic fundamentals of this country and the new government has the opportunity to signal loudly and clearly that Britain is a great place to do business – relentlessly focussing on investing in infrastructure, innovation and skills nationwide, while delivering a sensible and competitive tax and regulatory environment.

Putting trade, jobs and people first

“And now Brexit negotiations are beginning, it will be essential that negotiators on both sides remain cool, calm and collected, in order to make rapid progress on what a successful new relationship will look like. Putting trade, jobs and people first by agreeing transition arrangements and guaranteeing EU citizens’ rights early on would set the right tone. But the less likely a deal starts to look, the harder it will be for firms to recruit and retain talent as well as push the button on big investment decisions. ” Fairbairn stated.

She said that in order to achieve this, now is the time to build the best partnership anywhere in the world between business and government, shoring up the foundations of our economy. “Firms of all sizes, from start-ups to multinationals, are ready and up for the challenge.”

Calling for smooth Brexit to avoid cliff edge

British finance minister Philip Hammond pressed his case for a smooth Brexit that would avoid a damaging “cliff edge” for businesses as the country heads out of the European Union.

“We’ll almost certainly need an implementation period, outside the (EU’s) customs union itself, but with current customs border arrangements remaining in place, until new long-term arrangements are up and running,” he said in a speech at London’s Mansion House on Tuesday, Reuters reported.

Hammond also said he wanted Britain to lead a “crusade” for the opening up of services markets around the world as it leaves the European Union and he said the country wanted to remain open to skilled workers.

“It is not the time to raise rates”

Speaking to London’s banking community alongside finance minister Philip Hammond a day after Brexit talks started, Bank of England Governor Mark Carney said that now is not the time to raise interest rates, warning of weak wage growth and a likely hit to incomes as Britain prepares to leave the European Union.

“Before long, we will all begin to find out the extent to which Brexit is a gentle stroll along a smooth path to a land of cake and consumption. Monetary policy cannot prevent the weaker real income growth likely to accompany the transition to new trading arrangements with the EU.” he said.

Last week, three BoE policymakers of the eight on the Monetary Policy Committee unexpectedly voted to raise interest rates. Carney voted to keep them at a record low 0.25 percent and gave no sign he was in a rush to change his view.

“Given the mixed signals on consumer spending and business investment, and given the still subdued domestic inflationary pressures, in particular anaemic wage growth, now is not yet the time to begin that adjustment. In the coming months, I would like to see the extent to which weaker consumption growth is offset by other components of demand, whether wages begin to firm, and more generally, how the economy reacts to … the reality of Brexit negotiations.” Carney added.

He also underlined the importance of trade liberalisation – especially in financial services – and said it was unclear if Britain’s large current account deficit was yet on a sustainable footing.

Sterling hitting one-week low

Sterling fell by almost a full cent against the dollar on Tuesday after Bank of England Governor Mark Carney said now was not the time to raise interest rates, dashing some investors’ expectations the central bank had shifted in that direction, as Reuters reported.

Sterling sank to a one-week low of $1.2669 from $1.2758 after the text of Carney’s Mansion House speech was released. It was last trading at $1.2691. It also fell over half a percent to a five-day low of 88.04 pence per euro.

Ten-year yields on British government bonds fell below 1 percent after the text was released and last stood at 1.001 percent down 3 basis points on the day.

Short sterling interest rate futures also rose strongly, especially for the late 2018 and early 2019 contracts, as the market priced in a shallower path of interest rate hikes in future years.

The FTSE 100 stocks index, whose externally-focused companies often benefits from a weaker pound, was up 0.24 percent, slightly outperforming the pan-European STOXX 600 index . Consumer stocks were among the top FTSE gainers, helped by the prospect of lower interest rates for longer.

“Carney doesn’t want to be seen as reacting too quickly (to Brexit) – he’s also fully aware the UK hasn’t left the EU yet and he wants to keep his monetary policy loose on the off chance that the UK doesn’t get an amazing deal,” said David Madden, markets analyst at CMC Markets.

Sterling investors also kept a wary eye on politics, with the dual uncertainty of having no government at home 12 days after a parliamentary election and talks, which began on Monday, on Britain’s exit from the European Union adding to pressure on the pound.