The UK economy has “a lot of potential” and should bounce back strongly once uncertainty clears regardless of whether it leaves the European Union with a deal or not, according to BNY Mellon’s Shamik Dhar.
The risk for the UK economy, however, is that the Bank of England raises interest rates as soon as it can and derails a possible economic recovery, Dhar cautions. That's a concern expressed recently by Pictet’s multi-asset team, too.
Dhar, chief economist at BNY Mellon, says that he does not think that a no-deal Brexit would be as economically costly for the UK as many do. “Deal or no deal, I think the implications are pretty much the same,” he tells Morningstar.co.uk.
The biggest issue that would arise from the UK crashing out of the EU would be the inevitable aggressive sterling sell-off, as seen after the referendum in June 2016.
But, far from thinking the UK is in a bad place economically, Dhar, who previously worked as chief economist for the Foreign Office, doesn’t think the fundamentals are that bad.
Clearly, political instability and Brexit uncertainty caused a big drop-off in business investment through 2018, which fed into weak export numbers, exacerbated by a volatile global trade environment thanks to powerhouses the US and China.
So far, Brexit has pulled UK GDP down by between 1.5% and 2% relative to its pre-referendum baseline, predicts Neil Shearing, chief economist at research firm Capital Economics.
However, he added in a recent note to clients, it’s worth pointing out that the figure is dwarfed by the hit to GDP caused by previous economic and financial shocks. “For example, had the UK economy continued to grow at its trend prior to the 2008 financial crisis, it would now be 20% larger than it is today.”
UK Household Finances Robust
Elsewhere, households have cleaned up their balance sheets and both real wages and real incomes are now starting to pick up. Tuesday's data show average weekly earnings including bonuses increased by 3.5% in the three months to February 2019.
Inflation currently stands at 1.8%, but is widely expected to breach 2% on Wednesday's reading. Still, pay is now rising well ahead of costs.
Household finance figures for the fourth quarter of 2018, meanwhile, showed the largest quarterly increase in real disposable income since the second quarter of 2017 at 1%. In turn, that helped the household savings ratio increase to 4.5%, from 4.1%, in the fourth quarter.
This illustrates that households are benefiting from solid wage growth and below-target inflation, says Andrew Wishart, UK economist at Capital Economics.
And Dhar expects inflation to remain below target, with the feared sterling-related loss of trade now shown to have had a less-than-anticipated, one-off impact and having all but worked through the headline CPI numbers. This should all leave the consumer in a much stronger position.
Indeed, while at 0.3% the UK’s rolling quarterly growth rate is below the average rate of 0.4% recorded in both 2017 and 2018, it’s not that bad put in context of weakness elsewhere in the global economy, notes Shearing.
In fact, he adds, the UK economy appears to have grown at a similar pace to the US in the first quarter of 2019 and is likely to have outperformed the Eurozone.
Further, the slide in the pound through the latter part of 2016 helped boost UK manufacturers and had been hoped to bring about a rebalancing of the UK economy away from financial services and towards production. That reversed as sterling strengthened last year.
But we could see that process restart “quite significantly once we’ve got a modicum of certainty”, says Dhar, because there’s a lot of cash, particularly investment related, on the sidelines waiting to be deployed into the UK economy.
“If you look through that political fog, actually the fundamentals are in place for quite a reasonable recovery in the UK,” Dhar predicts.
Brexit Fog Won't Clear Until Halloween
Having said that, Dhar doesn’t expect that fog to clear any time soon. The UK’s extension until October 31 may be flexible, but it’s unlikely Prime Minister Theresa May’s deal will ever receive Parliamentary assent, but the probability of the UK leaving the EU before Halloween is remote.
And the European elections won’t help. In fact, Dhar thinks going through the process “will be very, very painful and intensify the political division, both amongst the political classes and in the country more generally”.
He foresees the UK sending divergent MEPs back to the European Parliament: “I suspect the turnout will be quite high and my guess is the MEPs we send back will reflect the country’s divisions. You will get a lot of angry leavers sending the new Brexit Party MEPs back, but also a lot of remainers turning out in force.
“That won’t necessarily clarify anything, so I’m afraid we’re in for a long, depressing summer of uncertainty and that’s the main drag on the potential for the UK.
“I’m not saying the UK’s going to grow at 2-2.5% this year because I think that political uncertainty will weigh on it for some time to come. But if it were to ever be lifted, then I think the potential for the UK to bounce back is quite strong.”
One concern Dhar does harbour is the course of action that his former colleagues at the Bank of England decide to take. “My concern is that they are itching to raise rates,” he explains.
Dhar says he was “very concerned” by comments late last year from both the Bank’s Governor Mark Carney and Deputy Governor Ben Broadbent. “They were so convinced that the supply side was damaged that they would be prepared to raise interest rates. That suggests to me that there is a certain eagerness [to hike rates] there,” Dhar says.
It’s something he thinks is a concern within central banks globally, not just the Bank of England, that policy makers are more worried about inflation than they should be. “They’re more worried about getting interest rates back to a level that gives them some ammunition during the next recession than I think they should be.”
The concern in the UK is that once the uncertainty clears, particularly if there’s a deal that is viewed positively, the Bank responds by upping interest rates. Dhar worries this would stymie what should be a strong rebound in UK GDP growth to around 2%.
