Nomura

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

  • Positive: Consumer spending should improve as inflation falls and wage growth rises; imports are slowing as households and firms switch spending towards domestically-produced items
  • Negative: Exports have not been enough to prop up economic growth given pressure on consumption and investment due to the weaker currency and uncertainty
  • Longer-term: Investment growth has been slightly stronger than the average before the credit crisis but the UK is lagging its G7 peers

Nearly two years on from the Brexit referendum, the UK’s latest annual rate of growth stands at 1.2% – the very bottom of the G7 (Canada, France, Germany, Italy, Japan, the UK and the US) league table. It’s a good time to assess the ongoing impact of this momentous vote.

The positive
Brexit is not all doom and gloom. Consumer spending should improve as inflation falls and wage growth rises. The global recovery and weak sterling should support exports while imports are also slowing as households and firms switch spending towards domestically-produced items. And the contribution to growth from the state sector should become less negative as the austerity programme is pared back.

The caveat
We expect the most significant negative effect of Brexit to appear in business investment. As a proportion of GDP, business investment is worth close to a tenth of overall spending. While that might not sound particularly large, its volatility is likely to ensure that investment has a significant impact when it comes to GDP growth.

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 – suffering 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 1%.

What’s the longer-term outlook?
Since the referendum vote, the annual rate of business investment growth has been around 2.25% – slightly stronger than the average rate in the decade before the credit crisis. However, when you compare the UK’s growth figures with those of its peers in the G7, the UK is 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% in 2018 and 2019 are materially lower than they would have been without Brexit.

Implications for inflation and 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 25bp each August and February – to take Bank Rate to 0.75% by end-2018 and 1.25% by end-2019.

We would have expected the BoE to have raised policy rates more swiftly had it not been for the Brexit vote. 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.

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