As the dust settles on last week’s referendum, pretty much every verdict I have heard or read agrees that the UK economy faces a period of contraction and the market has moved very quickly to price that scenario in. At first glance, this case is persuasive.
There has been clear evidence of deferred investment in the months running up to the vote. With months, or even years, of political uncertainty ahead, it is likely that some of that investment will be shelved indefinitely. There is already talk of overseas businesses, particularly from Europe and especially in professional services, reducing their exposure to the UK and relocating jobs to the continent. The early stages of a recovery in Britain’s banking sector have been set back and this will soon hit economic growth. A boom in new business creation by young entrepreneurs can only slow.
This is the consensus but I think it may be too pessimistic. Growth may take a dip in the near future, but there are reasons why it might bounce back.
The political backdrop will remain noisy in the coming months, but there is – arguably – quite a clear path ahead. The political centre of gravity in the country will take a step to the right. I expect the Conservative Party will return towards the centre-right, having spent the last six years occupying the centre ground. Labour, meanwhile, will return towards the centre, either in one go or by increments.
Sustaining economic growth and supporting business will become inevitable priorities for both sides. The good news here is that the last few years have seen only modest progress in this area as tight budgets and caution in the private sector have dominated. There is much that can change.
The other factor that could have an important influence on the performance of the economy and the direction of policy is the potential for core inflation to take off faster than expected. There are some important signs that this is already happening: nominal and real wages are on the rise, energy prices are recovering, while sterling is weakening.
All in I think price indices could still overshoot the expectations of both the market and the Bank of England. This would have some important consequences. First, it would support reported economic growth. Second, it would act to brighten the outlook for government finances which have struggled to improve despite a period of sustained economic expansion as low inflation and low rates have increased the present value of the debt. This in turn would give them a greater ability to support the economy in the years ahead.
The referendum has made prospects for inward investment to the UK uncertain and most observers are convinced that the current political climate will lead to more overseas businesses shelving plans. This would act as a drag on growth over the medium term, but again I think this assessment may prove to be too cautious.
Over the last 12 months, the value of sterling has fallen by around 15 per cent, and over 20 per cent since its peak against the US dollar in 2014. This means that all assets priced in sterling – be they physical property, intellectual property or human capital – look attractive in a global context. I expect to learn more about the impact of this as my colleagues and I engage with company management teams over the next weeks and months.
There are other factors at play which may trigger new activity: the uncertain outlook for end demand over the past few years has led to companies hoarding cash. This has been most visible in sectors such as software and healthcare but is a broader phenomenon. I think this suggests that the medium-term outlook for corporate activity remains robust and would not be surprised to see a number of significant bids for UK-listed companies before the year is out.
Amid the current market volatility and breathless political commentary, you may think me overly optimistic. But prevailing political states are almost never considered ideal. Economic growth can often follow a path quite independent from that desired or imagined by the political agenda. The relatively robust performance of the UK economy in recent years has been broadly-based and not heavily reliant on a single sector.
I don’t doubt the significance of last week’s referendum but it may be premature to assume that a contraction in the economy is a foregone conclusion.