Nomura

How has economic activity in the UK responded to the Brexit vote?

Nearly two years on from the UK European Union membership referendum, the UK’s latest annual rate of growth at 1.2 per cent has fallen down the economic league table to the very bottom of the other G7 (Canada, France, Germany, Italy, Japan, the United Kingdom and the United States) countries. How has the Brexit referendum outcome impacted the UK’s economy?

The not-so-positive:

Real exports of goods and services have expanded more quickly in the UK over the past two years than in many other countries thanks to past declines in sterling and strong global growth. However, this has not been enough to prop up overall economic growth, with other expenditure components – notably consumption and investment – having suffered due to a combination of the weaker currency and uncertainty respectively. Despite a more optimistic outlook for 2018, economists’ forecasts for consumer spending growth remain muted at just over one per cent.

The positive:

It is not all doom and gloom. Consumer spending should improve as inflation falls and wage growth rises, exports should be supported by the global recovery and weak sterling, imports are also slowing as households and firms switch spending towards domestically-produced items, and the contribution to growth from the state sector should be less negative as the austerity programme is pared back.

The caveat:

We expect the most significant negative effect of the Brexit process to appear in business investment. As a proportion of gross domestic product (GDP), business investment is worth close to a tenth of overall spending. While that might not sound particularly large, its volatility is likely to make investment particularly impactful when it comes to GDP growth.

What is the longer-term outlook?

Since the referendum vote, the annual rate of business investment growth has been around 2¼ per cent – slightly stronger than the average rate in the decade run-up to the credit crisis. However, when you compare the UK’s growth figures with those of its peers in the G7, the UK appears to be lagging.

Investment growth could well slow as the Brexit deadlines (March 2019 for de jure Brexit and December 2020 for de facto Brexit, based on the assumed timeline) approach. The greater the uncertainties associated with the Brexit process, the greater the likelihood of a sharper slowdown in investment spending.

Our forecasts for economic growth averaging 1.5 per cent across 2018 and 2019 are likely materially lower than they would have been without Brexit.

Implications for inflation and the Bank Rate:

Weak productivity growth and the closure of the output gap should eventually put upward pressure on domestically generated inflation. As a result, we expect the Bank of England to respond by raising rates four times over the next two years – by 25 basis points each August and February – to take Bank Rate to ¾ per cent by end-2018 and 1¼ per cent by end-2019.

We would have expected the BoE to have raised policy rates more swiftly had it not been for the Brexit vote. This time around, however, thanks to a combination of Brexit and exposure to the euro area during the sovereign debt crisis, the BoE has taken almost two years before responding to the Fed.

For more information on the implications of Brexit on the UK economy, read the full report on the Global Research Portal.

Contributor

  • George Buckley

    Chief UK Economist

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