Britain’s financial markets remain oblivious to deep-rooted problems

PUBLISHED : Monday, 05 June, 2017, 12:48pm
UPDATED : Monday, 05 June, 2017, 10:47pm

Nobody likes uncertainty, least of all financial markets. But for weeks, the British pound markets have been lapping it up, almost in complete abandon, despite dark storm clouds gathering on the horizon. British investors are pumped up and brimming with confidence, but the key question is: will it last?

Britain’s main FTSE-100 Index has been notching up record highs, the pound has remained steadfast and the bulls almost irrepressible despite abundant risks surrounding the general election battle on Thursday this week. With the latest polls suggesting a much closer race than first expected, investors ought to be running for the hills and battening down for an impending tempest.

It was a different matter a month ago, when British Prime Minister Theresa May called a snap election. The governing Conservative Party led the Labour opposition with a rock-solid 20-point opinion poll advantage. The economy looked in better shape, the opposition was wobbling and it seemed an apt moment to strike while the iron was hot.

The plan looked good on paper but has quickly fallen apart at the seams. May’s “strong and stable” image has crumpled, Labour opposition leader Jeremy Corbyn suddenly looks imperious and Britain’s top-slot place as the Group of Seven’s strongest-growing economy has folded. Britain could be heading for a hung parliament while its economic mood has turned much more sombre.

It is not the sort of message markets really want to hear, especially with share prices defying heady valuation levels. If investors were looking for excuses to sell, the list could be endless. The spectre of increased political risk, the heightened terror threat, Brexit uncertainties, moribund monetary policy and less-than-rosy economic data add up to compelling reasons for the bears to go on the offensive.

Britain has been awash with too much liquidity, thanks to the impact of home-spun and overseas-generated quantitative easing and zero interest rates. Investors have been blinded by a glut of easy money and lost sight of the country’s underlying fundamentals. The true picture is not pretty. Britain is a nation in long-term industrial decline and set for a brutal future shock, thanks to Brexit.

A year ago, economists were being savaged for getting Brexit “wrong”. The economy was supposedly in better shape than the “detractors” imagined. After all, Britain was top of the G7 growth tree, unemployment was falling and the country’s public-sector finances were returning to better shape.

But now, reality is hitting home with a vengeance. Britain has slumped to the bottom of the G7’s growth league table, mainstay consumer spending is starting to flag as real wages stagnate and the country’s booming housing market is losing momentum, too. Increased inflation, higher taxes and the impact of the pound’s slide after the Brexit vote last year have left consumers in a much weaker state. The country’s living standards are in decline.

Looking further out, there are deepening fears about what Britain will look like once the country leaves the European Union in the next few years. The risk of a capital flight from the US$1.5 trillion stock of overseas direct investment in the country could do serious harm to the economy, precipitating a pound crisis and a collapse in its financial markets.

Britain is a nation in long-term industrial decline and set for a brutal future shock, thanks to Brexit

In today’s world economy, industrial capital is highly mobile and the prospect of foreign corporations shutting British factories and relocating closer to the heart of the 500-million-strong European single market is really chilling. It happened to the United States when the dollar hit its peak in 1985, with domestic manufacturers deserting America’s shores for good in search of a better competitive edge.

Brexit uncertainties already threaten a flight to Europe by British-based banks worried about a future threat of EU sanctions. Dublin, Paris and Frankfurt are all set to benefit from any diaspora out from London’s financial centre. Losing this most valued “jewel in the crown” will be a bitter blow to Britain’s economy.

The pound market’s “win-win” outlook cannot last forever. British stocks rallying when the pound goes down and stocks going up when it rallies are a contradiction in terms. At some stage, British investors are heading for a wake-up call.

Anything short of a large outright victory by the market-friendly Conservatives will probably pull the switch on a major market correction. The “big win” is what market sentiment has been gambling on in recent weeks and its failure will hit the markets hard.

In the absence of rock-solid economic fundamentals, Britain lies prone to acute political risks.

David Brown is chief executive of New View Economics