Oo-er, suddenly the UK economy ain’t looking so good!
The news media are full of speculation about Brexit, and not many of the stories are looking forward to how wonderful the country will be once/if Brexit happens. We can expect more of the same for the next twelve weeks until Halloween.
Are we heading for No-Deal?
At the moment, both sides are digging in, trying to create a tough stance for the benefit of their populations (I hesitate to use the word electors when we are discussing the EU, but you know what I mean). Behind the scenes, it can be assumed that the diplomats and civil servants will see themselves as the grown-ups in the room, and thus be at least looking for common ground.
However, it seems unlikely that a comprehensive new Withdrawal Agreement will be crafted by October. But we can expect enough co-operation to keep the world turning.
So what’s the problem?
The problem is that investment is collapsing. The worst thing for businesses in uncertainty. Life has enough risks when it comes to business investment, without an unseeable future being only 12 weeks away. Similarly, house-buying and car buying are likely to miss out on their usual autumn surges this year.
And after Brexit day, will there suddenly be clarity and light? Nope. There will be hysteria in the media for a few weeks as every little shortage and business malady is blamed on you-know-what. And the effect of this – more hand-sitting and less spending.
What else is happening?
The US is starting to suffer from Mr Trump’s tariffs, to the extent that Jerome Powell has cut interest rates despite full employment. Meanwhile, China is suffering a marked slowdown from the trade war. This has now spread to Europe, which is also teetering on the edge of recession.
The UK is heading for recession – and it is difficult to see when it could end. Domestically, we’ll probably pull out next spring…. but that depends on what the rest of the global economy does. If things keep softening elsewhere, it could be a big one!
PS. The slowdown in Q2 announced today was no surprise, given the stockpiling in Q1 for the original Brexit day, and the factory shutdowns brought forward to April in case of Brexit delays.
PPS. The coming recession will be a direct result of Mrs May’s and Parliament’s timidity over Brexit. If they had gone ahead on 29 March, we’d be pulling out of it by now. The delay to October has just increased the uncertainty and halted the economy for 7 months, tipping us into a recession we need never have had.
It is accepted wisdom in the chattering classes that trade tariffs are necessarily a bad thing. But why is this so?
The Principle of Comparative Advantage was published in 1817 by an economist (yayyy), David Ricardo. This postulates that in international trade, relative advantages in labour costs, productivity and other production factors will enable cheaper consumption – and hence higher living standards – for both the producing and importing nations, than the alternative of home production in each country.
An easy example of this effect, even within the UK, was the impact of the railways. Suddenly, there was no value in each small town having a maker of pots and pans. Such items could be made better and cheaper by a huge factory in Birmingham, and so pan-buyers (Pans-People as they might be termed by grey-haired fans of Top of the Pops) had a better standard of living, having devoted less of their income to obtaining better cooking utensils. The pan-workers presumably had marginally higher wages than elsewhere too.
However, it perhaps wasn’t so good for the country-town pan-makers, who were competed out of a job. And some of the inhabitants of such villages may have mourned the disappearance of their friendly local manufacturer – and all the workers in the previous supply chain. Special orders would be more difficult, with just a few standard designs. So the nett gains, including non-monetary items, weren’t always as large as perhaps thought at first glance.
It is the principle of comparative advantage that postulates that we are all richer as a result of international trade. And tariffs dent international transfers of goods, hence at the margin impoverishing both exporting and importing nations.
A clear, and currently pertinent example is the UK beef industry. It is not cost effective for the custodian of 200 acres of Devon countryside, with hedges, copses and ancient barns to maintain, to compete with a mid-west American farmer with a 640 acre (square mile) of flat, fertile, but featureless maize land. The US beef farmer keeps all his animals in a feed-lot year round and transports in fodder from the prairie or the local grain silos. Cheaper feeding with no overheads – oh, and growth hormones. Does the UK consumer want cheaper beef, or enough profit in UK farming to retain our beautiful countryside? In surveys, they would select the countryside, but I suspect in Morrisons they would choose the cheaper steak! So the UK farming industry will need tariffs to raise food prices or, alternatively, subsidies to maintain the countryside.
What do tariffs mean in terms of Brexit? In the case of a No-Deal Brexit, then the EU could choose to treat the UK as a third party country and apply tariffs. (It could drop tariffs on the basis that a withdrawal deal or trade agreement is imminent. It’ll be interesting to see if there is sufficient goodwill for that to happen). Given the 15% fall in sterling, the average 3% cost of tariffs across all goods won’t actually make much difference. However, in cases such as beef and lamb exports to EU, 40% tariffs will hurt. Here, sector support will be essential during any interim period, as the reaction of prices to these tariffs will be only partly a rise in prices in EU, with the rest of the slack taken up by a fall in export incomes received by British farmers.
The second impact of leaving the EU’s customs union will be an increase in paperwork. This is just sand in the machine, benefiting nobody (except perhaps paper-makers and form-fillers).
Work will be required on both sides of the channel to ensure delays don’t become excessive. We have seen figures suggesting that if the processing time per lorry increases from 30 seconds to a minute and a half, then the whole of southern England will somehow face gridlock. This view doesn’t seem credible to those without a pre-decided political position. Both sides of the channel have had plenty of notice about the forthcoming change, and already have capacity to cope with fluctuations in volumes. If each lorry needs three times as long to be processed, then is it not a case for having three times as many booths? Or maybe twice as many with a few changes to reduce the bottle-necks or critical time-paths of each customs inspection?
Finally, there is the Irish economy to consider. The vast majority of their goods travel across England to get to continental Europe. If tariffs are bad for the UK, they will be hugely worse for the Irish. Will they pay a tariff to get their goods into UK and another one to move them into France? One has to hope that Brussels won’t dump the Irish economy as a side-effect of punishing the UK!
In the very long-term, one has to assume trade deals will be made with both EU and US. There is some prospect that we will have to choose whether to be in the trading orbit of the US or EU, as having one foot in both may be untenable.
Tariffs (and paperwork) are bad, but not catastrophic.
The already lower pound sterling, and future tax and export-subsidy payments will mitigate the worst impacts.
Brexit is a political choice. Tariffs are a part of that decision, but should only be a small input, not the deciding factor.
Anyone who lived through the 1999 tech-stock bubble will remember that the Lastminute.com float in March 2000 was as close to a huge flashing warning light (with 100 dBA klaxons sounding) that the market ever gives. And for those too young to remember, here is Lastminute’s first-year price chart.
And now we have Uber. A company modestly valued at $90bln. Say it quickly, and it doesn’t sound so huge – but it is $90,000,000,000.00 – for a company that is a neat idea, but has yet to turn a profit.
Its core business is a booking app for mini-cab drivers. We are all for making life more efficient, and Uber has first mover advantage, but the barriers to entry are pretty low. Anyone could setup a rival, and many have done so.
So one has to ask, will this core business of ordering a mini-cab ever make any money? There are some clear barriers. In London, a legal ruling has determined that the drivers are employees – and hence are due minimum wages, holiday pay and so on. This is under challenge, but potentially will load a large cost increase on to Uber. And then, if they are employees rather than independent businessmen, suddenly Uber will have to start charging VAT. That’s another 20% on the price. In addition, if all the Uber drivers are employees, will there be so many of them hanging around on the London’s Embankment waiting for your call? My guess is that Uber would work much harder at matching supply to demand – so the quick arrival of your Uber-Prius, may slip back too. Much higher prices and worse service is not a great way to develop a business!
So the core business is looking vulnerable to say the least – unprofitable and with significant extra costs on the horizon.
“Ahh” say the fans, just wait until Uber completes its self-driving technology. Than all the above listed complaints go away (with all the drivers). There are just two small problems with this vision;
Such technology is a very long way into the future. My spies in the industry reckon at least 10 years.
Every motor manufacturer on Earth (except Morgan, perhaps) is working at the same target of offering self-driving cars. So there will be a multitude of offerings, and it is far from clear that Uber will have any kind of first mover advantage.
The investment community is often chastised for being too short-term, and worrying only about the next quarter’s figures. We can be sure that at some point in the next 10 years, the market will lose faith in Uber and the shares will crash and burn – which is a very unfortunate event, especially for a car company.
Last month, back in those happy days when we believed Brexit would be sorted by the end of March – Yep, we were writing on 26 March – we made our GBP forecasts on the basis that No Deal would provoke a bit of a dip, whilst No Brexit would have a slight spike, but in either scenario, sterling would end up stronger against USD and EUR.
Things have changed over the last 3 weeks – but still they are the same. We continue to not know what is happening with Brexit. We could be heading for a No Deal at the end of October, we could be getting Mrs May’s Deal approved (though it seems unlikely), or we could be having a new Tory PM and a bit of re-negotiation.
Whatever happens, we feel that the UK economy will continue to motor along okay, with investment decisions increasingly being taken anyway. Life goes on eh? The UK data seems to indicate that this is occurring, with strong employment and wages data, and quiet inflation.
US Non-Farm Payrolls were 196,000 in March, which matches our “decent level target” of 200,000. China seems to be stabilising its recent weakness. So it is only Europe skating on the thinnest of economic ice.
So whilst we see GBP strength still, it will not be as robust as we thought – until Brexit is fully resolved. Thus, in 6 months time, we see GBPUSD rising from today’s 1.30 to 1.38 (forecast down from 1.42). However, there is a serious risk of weakness in the EU area, so we still see EUR weaker against GBP. As last month, we expect EURGBP to fall from 0.8680 today down to 0.8200 in 6 months time regardless of the B-mess.
How do they do it? It continues to amaze how the politicians can pull the worst possible deal out of the bag. I guess that’s what happens when you go begging!
The delay until 31 October is too short because;-
The new deadline is not far enough into the future that we can all forget about it and go back to investing in businesses, making a living and getting on with out lives without constant uncertainty. So any rebound in the economy will not happen this summer.
There is insufficient time for the Tories to organise themselves, get a new leader and negotiate a better deal. So we are stuck with the May Deal, No Deal or No Brexit. Even an election or a re-run off the referendum don’t really have enough time.
Given the local elections, the European elections, summer recess and the political conference season, there isn’t even much parliamentary time over the next six months.
The delay until the end of the summer is a disaster because;-
All of the stockpiling and emergency plans will have to be maintained – or run down and then rebuilt. So either a long summer of warehouse costs, or absurd gyrations in the supply lines, with no orders for 3 months as stocks run down, and then double orders for the next quarter as supplies are built back up again.
The Relief Bounce to the economy for which we were all hoping will not happen whilst we continue to have the black Brexit cloud thwarting any enthusiasm. So another summer of missed growth.
The pressure is now off the politicians to sort a deal – so nothing much will happen for 4 months – then suddenly they’ll realise that we have a deadline coming, and like a rash student before finals, they’ll be up all night arguing and still not agreeing anything.
WHAT A SHAMBLES. Just when you think our political class couldn’t make things any worse, they go and under-reach our expectations yet again.
Sadly, the most lasting legacy of this whole farce will be a long-lasting contempt for all politicians and for our democratic system. Whilst the MP’s deserve derision, such strong dissatisfaction with politics is not a good thing.
The Green Belt system was created by that great reforming Post-war Government. And like that administration’s other much-loved offspring, the NHS, the general public has massive affection for it.
Fourteen cities in England are restricted from ever greater sprawl by green belts. That has to be a great thing right? We all love our green and pleasant land, so what is not to like? Well quite a lot actually.
By limiting a city’s growth outwards, the inevitable effect is increased population density; more stressful living in ever smaller dwellings and more congestion – and the pollution from more people concentrated in a restricted area.
This increased pressure on land use means that existing green spaces within the city will be slowly lost to development. And so the crammed-in population – who have very little access to the greenbelt farmland – have less natural environment than in a larger, less constrained conurbation. The city loses its lungs.
Limiting the size of a city will increase land prices as people and businesses compete for a scarce resource. So lower added-value work leaves the city to cheaper environs – and the lower skilled are thus forced out too. You really can’t get the staff, dear.
This same increase in land prices, plus the congestion of a termite-hill city, encourages people to commute away from the city, out across the green belt to towns and cities which would otherwise be way beyond the commuter zone.
For example, thousands of people commute into London every day from places as far away as Southampton, Oxford, Coventry and Peterborough. There may be a small element of wanting to live in these places anyway (though not Coventry and Peterborough, obviously). But the real reason is economic. Away from London, a larger house with a garden is so much cheaper that the pain and expense of commuting remains attractive. Imagine all the extra pollution, greenhouse gases and lost productivity from these long-distance travellers. All the London Green Belt has achieved is to move the growth that would have occurred around London to be spread over the whole south-east of England.
Despite the positive image, and just like the NHS, the law of unintended consequence looms large over the green belt. We don’t want to see it abandoned, but it does need to be slackened off a notch or two.
After months of indecision, our politicians have finally given the country what it needed – a certain route forward. The economy has taken a pounding and politicians have been in utter contempt (and been held in total contempt) for what seems like a lifetime.
Views diverge on the economics of the deal. Our belief is that the agreed May + 5 Year Customs deal is better than staying in forever and only slightly worse than leaving quickly. But nobody can deny that the lack of certainty has caused a lost year for the UK economy, with businesses totally distracted from any investment or expansion plans.
And who would have thought that the breakthrough could have been by Jeremy Corbyn? His mission to persuade the EU to fast-track the Palestinians for EU membership was inspired. Surely it can be only a matter of time before many other Middle-East countries decide that life is unbearable outside the EU – or the MEU as we’ll have to call it. Even the war between Saudia Arabia and Yemen will be solved once they have a frictionless border within the EU. Isn’t it great that all of the 245 Labour MP’s realised how Mrs May’s deal was almost identical to Labour policy and could be whipped to approve it over this wonderful triangulated issue?
OK, so it might be a bit tricky if Israel win the Eurovision Song Contest again, but let’s sort the details later.
Hurrah for Theresa May, Jeremy Corbyn and all our wonderful MPs, who have governed this country so selflessly and magnificently!
PS. Can I have the prize for the World’s Least Plausible April Fool Ever? Honestly, nobody actually could believe that Brexit has been sorted, could they?
What is happening to sterling? You’d think it would be thrashing around like an angry hornet stuck in a beehive hairdo.
But it remains calm , as has done since last autumn. Under normal circumstances, GBP acts like a divorce-child, torn between Europe and the US. Sometimes it goes with the Euro, on other occasions it sticks with the US Dollar. And very infrequently, enough happens in UK for it to make a simultaneous move against both its “parents”.
So what is happening now? Are currency traders;-
a) woefully short-sighted and not interested in Brexit, as it won’t happen today or tomorrow?
b) utterly complacent about Brexit and not factoring it in the price at all?
c) estimating that the percentage chance of No-deal has not changed, and so the effect on GBP has not altered?
But here is a little heads-up!
Currencies do move on matters other than Brexit. Hard to believe isn’t it, but there are a whole range of different inputs into a currency price? You know, GBP did move up and down before Brexit – and it will continue to trade after Brexit has either died or been settled.
Since our last currency forecast on 5 February, “Cable To Go Higher On Brexit”, the Brexit debate has moved on a little, in that it now appears to be more binary – No Deal or No Brexit. More on this tomorrow (sorry).
The world economy has slowed too. US Non-Farm Payrolls (our fave number) were weak in February. Europe looks weak too, with German industry catching a cold from China. Let’s hope that doesn’t become Asian ‘Flu. Meanwhile, the UK economy continues to trundle along with record employment and flaccid inflation. Suddenly, that isn’t looking too bad.
Interest rate rises seem to be off the board in all main economies, with the chance of more QT in the Euro Zone.
So to the forecasts.
a) No-Deal Brexit is probably 20% in the price of GBP already. If it happens, then watch out for some weakness against USD in the short term, but strength once the media-highlighted logistics problems are resolved, the strong UK fundamentals come into play.
We see GBPUSD at 1.2800 in a month and at 1.4200 in 6 months under this scenario.
Against the EU, we think No Deal is nearly as bad as for Europe, and so the EUR will maintain its level with GBP on a one-month basis at 0.8600. Over 6 months, we seen GBP stronger against EUR, with EURGBP at 0.8200 in September.
b) No-Brexit (aka Long Delay) then we see the same forecast levels in 6 months (driven by fundamentals), of GBPUSD at 1.4200 and EURGBP at 0.8200, but with a step up (provoked by guess what) rather than a dip in the meantime.
PS. Well done if you liked our pounds shillings and pence pun in the title. No prizes for spotting it though.
We do not believe that Brexit will dethrone London from being Europe’s pre-eminent financial centre.
Back in 2017, Xavier Rolet forecast that leaving the EU could cost 200,000 jobs in London. By January this year, Nomura had the number down to 10,000. Our expectation is that approximately 5,000 people will actually be re-located from London to a different EU city. According to the statista.com website, the total number of financial services workers in London is in the region of 350,000. Thus the change represents about 1.5%, which is substantially less than the normal annual fluctuation. And we believe that these jobs/people will likely trickle back over the next few years.
The reason is agglomeration economics. The EU would love to grab hold of such a high-earning industry – and to be able to closely control capital flows and investments. Their challenge in making it happen – which they will not meet – is partly that they want to control the industry, which frightens it away. The major hurdle though, is that their financial services are too dispersed – and national-competition is unlikely to let them pick one centre to develop.
Of those people leaving London, many have gone to Dublin, but others have gone to Frankfurt, Luxembourg, or Milan. Following President Macron’s temptations, a few have even gone to Paris, despite the tax rates.
The aforementioned agglomeration economies result from having a high-concentration of an industry in one place. Lots of good employees are drawn there by the multitude of opportunities, giving a great pool of talent from which banks can choose. A wide array of support industries appear: everything from specialist lawyers and accountants, to top restaurants, schools and transport systems. Informal and formal communication methods encourage the spread of information and best practice. This productivity-by-concentration applies to London, but not to any other single city in Europe.
In time, we expect a passporting agreement will be struck with the EU – but from a position of strength. European banks, companies and individuals will need access to London’s financial markets just as much as London wants frictionless financial customers across Europe. EU intransigence could mean this takes many months or even years to happen – but happen it will. London will thrive and grow inside or outside of the EU.
Politicians like to think they are in charge – but in the long term, they can’t beat economics!
Anybody got a dinner party coming up? Here is a briefing on the London Market Comment forecast for house prices.
Where we are now
The current market is totally flat, with Nationwide reporting prices in February just 0.4% up in 12 months. This is within the margin of error from 0% I would suggest. Meanwhile, Halifax are due to report their latest numbers on Thursday this week, where another flat outcome is expected. For more heavyweight predictions, Savills produced an excellent report late last year, which foresaw prices pretty much flat for 5 years in London and the south east, whilst growth of about 3% was expected in the Midlands and further North. Rental income was seen to follow earnings at about 3.5% pa.
Anecdotally, we hear of much greater falls in London than the official figures, with 25-30% mentioned for top-end Central London addresses. All those poor bankers. What is that red stain on my shirt? Oh it’s my heart bleeding! Outside London, the top end of the market is equally dead, snuffed out by Brexit uncertainty and eye-wateringly high levels of stamp duty. Thank you for both of those Mr George Osborne!
The Ripple Effect
However, these stumbles in London do have an effect on the rest of us mere mortals. The Ripple Effect is a well-renowned phenomenon where the impact of London residential price changes slowly spreads out to the rest of the country. There has even been academic support for such observations, explaining how each neighbouring micro-market for houses catches whatever is happening a short distance away when some buyers notice price disparities and vote with their feet, causing falls to spread out from one neighbourhood to the next. (Jones and Leishman (2006) ). The research would suggest that the falls in London prices should be expected to be exported across the the regions.
The Brexit Effect
Didn’t we do well, getting all this way into the article before mentioning the B-word? Clearly, the political uncertainty has caused some buyers throughout the land to wait and see what happens. If we leave with a Fig-Leaf Deal at the end of March – which we continue to expect – then the market is likely to release its pent up demand only slowly over the remainder of 2019. Any other outcome or political fudge will delay a market recovery.
The Commercial Property Effect
Despite the expectations of many within and without of the property industry, the market for prime commercial property in London remains well-supported. We see the influx of overseas investment continuing. The burgeoning institutional move into Buy To Let (rebranded as Build To Rent, oh those cynical marketing types) will tend to support the housing market.
Foreign investment in the UK residential market has clearly been reduced by the mood music from Government. Private landlord investment has also been stymied by raised tax and stamp duty rates. Meanwhile, the proportion of owner occupiers is rising, which could be seen as the desired response to these initiatives.
Supply and Demand, Stupid!
The British public speaks with forked tongue on hosing prices. On one hand, they love it when their largest asset grows in value. However, they hate it when their children can’t afford to buy a house of their own. Most of all, the public refuses to countenance building over Green Belt or countryside of any kind. As long as our population grows, and our nationalisation of land use control continues in the form of Planning Restrictions, with local political control, there will be housing shortages and prices will be restrained only by affordability.
There is uncertainty in the air, but high employment and low interest rates – and thus little expectation of forced sales. Over the next 6 months the market will remain subdued, even if the politicians suddenly start behaving like leaders. We see changes of +/- 1% over the rest of 2019.
From 2020 onward, we see house prices rising as fast as earnings will allow, which means 3% pa, with more in London as it re-asserts its dominance over the UK (and northern European) economy. In the long run, London will continue as a Mega-city, and you can’t beat economics! Starting next year, London prices will bounce back, cancelling any ripple effect and supporting earnings-related rises across the country.