The swift formation of a new government and the opportunities created by the pound’s fall have quietened the doomsayers. But risk experts have downgraded their views on the economic outlook and government stability after the referendum, with so much that is still unknown.
The UK's investment environment has taken a knock after the referendum vote result
Euromoney’s country risk survey shows a clear distinction on prospects for the UK between the pre- and post- Brexit referendum contributions from economists and other expert contributors.
All five economic risk indicators, and all six political ones, were downgraded when the outcome emerged, pushing the UK down one place in the global rankings, to 19th.
The biggest change occurred to the economic outlook, reflecting the fall in confidence and the risks of losing access to the Single Market when the UK divorces from the European Union (EU):
UK experts had felt there would be longer-term advantages to the UK withdrawing, in terms of reduced regulation and more control over trade policy, which hasn’t changed, and the dire predictions emanating from the Remain camp’s “Project Fear” are considered to be wide of the mark.
Tellingly, the survey indicates that the UK is still a safer prospect than France, which is more than three points worse off and seven places lower in the rankings.
The political fallout for one thing would have been worse had it not been for the Conservative Party pulling together and ensuring a smooth transfer of power to the new prime minister, Theresa May, following David Cameron’s resignation.
The prospect of a snap general election has eased, too, as May and her cabinet colleagues dodge calls for seeking a new mandate for the Conservatives in favour of shoring up public confidence following the shock outcome, easing market fears.
Nerves are still jangling
Yet there is still considerable uncertainty over what those new trade arrangements entail.
The Scottish devolved legislature and administration is meanwhile pushing for another independence referendum north of the border, raising the prospect, however unlikely, of the UK splitting apart.
France, Italy, the Netherlands and other EU member states might find it hard to resist public pressure for referenda on EU membership, leading to the possibility of other countries following a similar path and harming Europe’s fragile economic recovery.
In the meantime, a new path is already being traced out for the UK economy, depicting weaker growth compared with pre-Brexit expectations.
In such an environment corporate boardrooms are cautiously watching what happens next, with sectors more closely integrated into the EU likely to be less willing to commit to expensive outlays, despite the attractions of UK PLC to foreign investors capitalizing on the exchange-rate shock.
In that light, UK economists are naturally pessimistic about the UK’s prospects.
The pound has come off its worst point after crashing in the first days after the plebiscite was staged, but at around $1.32 it remains sharply below its pre-Brexit position of $1.50, and will tip the UK’s low inflation rate upwards in the coming months.
Contributing consultancy Oxford Analytica, echoing the views of others, says it might take years to conclude a trade deal between the UK and the EU.
HSBC, which also takes part in the survey, has outlined a post-Brexit forecast of “stagflation” – slower growth and higher inflation – following the referendum.
These downbeat views are shared by Euromoney’s survey contributors based abroad.
“I am convinced that Brexit will be clearly negative for British citizens and entrepreneurs,” says ECR survey contributor Norbert Gaillard, adding: “Very recently, [Bank of England Monetary Policy Committee member] Gertjan Vlieghe has said that economic growth is already slowing down.”
Johan Krijgsman says: “Growth numbers during the transition period will be weak, and at times negative.”
Gil Bufman writes: “The damage to economic activity will be felt through a number of channels: weak consumer and business confidence levels; a decline in investments; heightened perception of credit risks, against the backdrop of estimates for a reduction in the credit rating; and an increase in finance costs for companies.”
Fiscal plans go awry
The appointment of former foreign secretary Philip Hammond as the UK’s chancellor of the exchequer (finance minister), to replace George Osborne, has left investors in a quandary, as is clear from the swift pronouncement from Moody’s of a negative UK credit rating (changed from stable).
Hammond is considered a “fiscal hawk”, and will be expected to manage the nation’s finances prudently. He has also ruled out an emergency budget, and will announce more details on the government’s fiscal spending when the autumn statement is produced according to the timetable, later in the year.
Yet his job has now become harder as a consequence of the downgraded economic growth projections from the IMF, among others, and eyebrows were raised when he indicated that the government will no longer target a budget surplus at the end of this parliamentary term (to 2020).
Forecasts produced by the European Commission in May showed the fiscal deficit narrowing, but with very limited room for manoeuvre given that the UK’s general government gross debt was already touching 90% of GDP.
Plus, the UK must ramp up its professional civil service capabilities for handling Brexit, at a substantial cost to the Treasury.
Thus, although the UK has survived the initial weeks without severe consequences, the conclusion remains the same.
Brexit might be a boon in the longer term, but the road to such an outcome is littered with hazards, which is something the bond markets seem to concur with. The UK curve is flatter than those for the US and Germany, where risk appetite is greater.
The implication is that the UK’s relative risk has increased, and interest rates will need to be kept lower for longer.