21 Aug 2017
Author: Richard Jerram, Chief Economist, Bank of Singapore, Member of OCBC Wealth Panel
The British government is starting to produce more details of its plans for Brexit as it heads into another round of negotiations. The lack of practical proposals shows that the process is still in its infancy, more than a year after the referendum. The uncertainty is already starting to hurt the economy.
Most seem to accept that a transitional arrangement will be necessary, as the terms of exit are too complicated to be settled by March 2019. Moreover, negotiations on trade access cannot begin until the UK has left the European Union (EU).
However, there is no clarity on what a temporary trade deal might involve, let alone a permanent one. The government’s lack of a realistic plan was evident in a recent paper (here) and the process will probably be driven by whatever is acceptable to the EU.
For the UK, a serious problem is that the EU wants agreement on the divorce bill, the rights of Europeans living in the UK and the border with Ireland before it will talk about the future relationship with the UK. All of these issues are extremely divisive in British politics, with no evidence of a clear, workable policy. The inconclusive UK election in June has further confused matters and British negotiators appear to have unobtainable targets, often with an apparent lack of understanding of core issues.
There is even a persistent hope in some areas that the UK could hold another referendum to reverse the process. The first vote generated so much ill-feeling that going through it again in a re-run looks unlikely. However, growing recognition of the complexity and costs of Brexit argues for maintaining relatively close ties with the EU.
The concern is that the lack of clarity on post-exit relations with the EU generates uncertainty that hurts economic growth. A British firm that exports to the EU might wonder about the best location for its next investment. A French citizen might hesitate to buy London property if he is unsure about residency rights. Already we are seeing financial institutions setting up alternatives to UK operations.
The impact on the real estate market is starting to be evident. Mortgage approvals have flattened out and London property prices are stagnant, but so far no worse.
The overall damage from the Brexit vote in mid-2016 was lessened by the sharp fall in GBP, which helped the export sector. So far the economic performance is mixed, but not terrible.
The consumer is struggling, probably because higher inflation (partly due to the weaker exchange rate) has squeezed spending power, which has hurt retail sales and confidence. However, business conditions are still reasonable and solid labour demand has pulled the unemployment rate to the lowest level in decades.
As with the housing market, the overall economic situation appears to be stalling as we await more clarity on Brexit. This could drag through 2018.
The Bank of England has recently shown signs of wavering from its stance of tolerating an inflation overshoot due to fears about the downside risks to growth. However, an early interest rate hike is hard to justify and we expect a continued wait-and-see approach. GBP looks cheap, but it is vulnerable and there is the danger of a final leg down if (when?) Brexit negotiations turn messy.
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