Brexit pain is just beginning, and it’s about to get a lot messier
15.5pc plunge in the pound against the dollar has pushed up prices amid weak growth in wages, and squeezed British household purchasing power
As recently as last November, retail sales in the United Kingdom (UK) were expanding at an annualised rate of nearly 6 per cent, nearly as strong as the 7.2 per cent rise in October, the fastest annual increase since April 2002.
For the Conservative government of British Prime Minister Theresa May, who last month confirmed the UK is determined to make a clean break from the European Union (EU) in response to Britons’ unexpected decision last June to vote to leave the 28-member bloc, this was proof that the doom and gloom over “Brexit” was overdone.
Last month, the International Monetary Fund (IMF) even raised its growth forecast for the UK economy this year from 1.1 per cent to 1.5 per cent, the biggest single upgrade of any major economy in the IMF’s January update of its economic forecasts.
Brexiters were given further reason to rejoice earlier this month when the Bank of England, which shortly after the Brexit referendum predicted the UK economy would grow by just 0.8 per cent this year, also raised its forecast for growth in 2017 to a brisk 2 per cent, the same rate as last year.
Yet if supporters of Brexit think it is plain sailing from here on in, they are sorely mistaken.
The strain is already starting to show on the UK’s economy.
In December, growth in retail sales proved weaker than expected in annualised terms and even contracted on a seasonally adjusted basis (which strips out the effects of Christmas) relative to the previous month, a much sharper drop than analysts had expected.
Then, last Friday, hopes that December’s bleak data were a one-off were dashed when it was reported that UK retail sales in January fell for the second consecutive month in seasonally adjusted terms.
For the first time since the Brexit referendum, consumer spending - the mainstay of the UK economy – is slowing sharply because of the 15.5 per cent plunge in the value of the pound against the dollar which has pushed up prices in the retail sector amid weak growth in wages, thereby squeezing British households’ purchasing power.
Currency investors, who are the most sensitive to the risks stemming from Brexit, took note, with the pound falling 0.6 per cent versus the greenback last Friday.
While the UK economy performed surprisingly well in the final quarter of last year – revised GDP data published on Wednesday showed that growth accelerated to 0.7 per cent relative to the previous quarter instead of an earlier estimate of 0.6 per cent – net trade and manufacturing were the key drivers of the expansion.
Consumer spending, which accounts for roughly 60 per cent of the UK’s economic output (in stark contrast to Germany where exports account for approximately half of the country’s GDP), is emerging as a major focal point of anxiety for analysts and market commentators.
That concerns about the health of Britain’s economy are growing just as the May government prepares to trigger the UK’s formal divorce talks with the EU by invoking Article 50 – the legal mechanism for exiting the EU which sets a two-year deadline to reach a deal – next month raises the stakes further.
Over the past three months or so, markets have become less concerned about Brexit and are now starting to worry about the risk of a “Frexit” as Marine Le Pen, the leader of France’s far-right National Front (FN) party, narrows the gap with her rivals in the country’s presidential election campaign.
Yet Brexit is about to get a lot messier.
While the legislation to trigger Article 50 has already been approved by Britain’s House of Commons (and is now making its way through the House of Lords), the negotiations between the UK and the EU will be extremely fraught and could even result in Britain crashing out of the bloc with no new trading arrangements in place.
The EU’s Brexit negotiators are determined to force the UK to settle its divorce bill – which is estimated to run to some 60 billion – before entering into detailed discussions on the UK’s new trading relationship with the EU.
This would scupper May’s plans to hold parallel talks on Britain’s financial liabilities and a new trade deal, potentially leading to an ugly standoff in Brexit negotiations and putting renewed pressure on sterling.
While investors are focused on French political risk, they would do well to pay as much (if not more) attention to developments across the Channel.
Nicholas Spiro is a partner at Lauressa Advisory