13 June 2018Analysis

UK economy suffering from Brexit uncertainty on nature of final deal

The UK economy is feeling the effects of the country’s move to leave the European Union and there could be even tougher times ahead, two notable economists agreed at a panel discussion held on Wednesday morning at the annual  Bermuda Captive Conference, which is taking place at the Fairmont Southampton Hotel on Bermuda this week.

The session, called ‘The Economists’ View’, was chaired by Tom McMahon, president, Citadel Management Bermuda, and featured two economists: Henk Potts, director of global investment strategy, Barclays; and Daragh Maher, head of FX strategy US, HSBC Securities.

Potts noted that the UK has been struggling as the “reality of Brexit starts to shine through” going from one of the fastest growing economies in the G7 to one of the slowest. And it could be under pressure for several years to come, he said.

“We think it will continue to be under pressure for several years. Business investment is lackluster – businesses will commit to two-year investment programme but not longer than that because they don’t know what access they will have to the EU.” He said that Barclays predicts the UK economy will grow by 1.3 percent this year – lower than the Eurozone.

Potts said that negotiations on the nature of Brexit are further ahead than some analysts predicted and it is positive they have now moved beyond agreeing the detail of the nature of the exit or ‘divorce bill’ onto Phase 2 – the nature of future relations.

“But the second phase is tougher,” he said. “The idea of the transitional period is a good one and broadens the time horizons but big differences remain on some critical points such as the future trading relationship. The UK wants bespoke access, effectively cherry picking what it wants, whereas the EU says it will not allow that.

“This will be critical to business and investors and define whether it is seen as a hard or a soft Brexit. The problem is that the clock is ticking and decisions need to be made.”

Maher agreed that the UK economy is weakening and will continue to do so. He said it was unlikely the Bank of England would increase interest rates in the foreseeable future as result. But he disagreed with Potts on the progress that had been made and the continued risk.

“I’m not sure negotiations have got that far; we think the market is underpricing the risk of a no deal outcome. It is all very well have a transition period but you need to know where you want to head at the end of that. There are some seemingly irreconcilable issues such as the Irish border and something will have to crack eventually.”

Maher likened the situation to a couple going into a market to haggle for and buy a rug. “But they don’t even know what type of rug they want or what they are willing to pay.”

They also discussed the possibility of Brexit not going ahead or there being a second vote. Potts said there would not be a second vote. “Democracy has spoken and they will push ahead; only the type of deal is debatable,” he said.

Maher suggested that should two potential scenarios be agreed – one representing a soft Brexit and the other a harder version – there could be a vote on this. He said he believed the most positive outcome would be that very little changes.

Potts said the idea of voting on two versions of Brexit would now be messy and impossible given the time scales involved. He admitted it was tough to come up with positives from Brexit but suggested two: “If you believe the EU project will eventually fall apart, it is better to leave a sinking ship earlier,” he said. “And maybe freed from EU bureaucracy, we can establish trading relationships with other parts of the world and our friends in the commonwealth. But trade deals on average have taken more than six years to do in the past so it is tough to see anything happening quickly.”

Potts said that he felt sterling looked cheap from a valuation perspective, as if the markets have priced in the worse case scenario now. Maher responded: “But it is like a car with a dent and its wing mirror hanging off. It will be cheaper. Plus, it is acting as a shock absorber helping manufacturers. Things would be a lot worse if it was not cheap.”