Brexit: Was it Just a Nasty Dream?

Recent data suggest the British economy is weathering the fallout from the referendum vote better than almost anybody expected. This reduces the likelihood of more monetary policy easing this year, taking some pressure off the pound.

Initial Indications Were Bleak

It’s now almost three months since the UK’s momentous vote to leave the European Union (EU). In this time, we’ve had little clarity on the likely shape of the UK’s future trading relationship with the EU or the way in which the government intends to handle the exit negotiations (or even when they’ll start).

But we’ve started to get more information on the near-term economic impact. And while much of this has been in the form of survey data, experience tells us that these shouldn’t necessarily be regarded as inferior to the less timely official data—which can be volatile and are often heavily revised.

So what do the data tell us? Initial indications weren’t good. The composite Purchasing Managers’ Index (PMI) for manufacturing and services fell by a record 4.8 points in July, consumer confidence experienced its biggest setback since the early 1990s and the housing-market survey conducted by the Royal Institute of Chartered Surveyors (RICS) showed a collapse in both price expectations and buyer enquiries.

At that stage, it seemed that the dire warnings issued by many commentators and policymakers before the referendum were coming true with a vengeance.

With recession beckoning, the Bank of England’s Monetary Policy Committee (MPC) chose to ease policy more aggressively than expected at its August meeting.

Different Picture Is Emerging

But with the benefit of another month’s data, a different picture is beginning to emerge. The July drop in the composite PMI was followed by a record six-point gain in August. The latest reading of 53.6 is above both the June level (52.4) and the average for the first half of the year (53.3).

It’s also broadly consistent with economic growth of +0.4% to +0.5% a quarter, close to the average over the last year and a half (+0.5%).

The recovery in other indicators has been less dramatic, but still quite impressive. Consumer confidence has already recouped half of July’s loss and is now up above its long-term average. And some measures of consumer optimism, like current buying intentions, have moved back to pre-referendum levels. Finally, turning to the housing market, the price expectations and buyer enquiries components of the RICS survey are at their highest levels since March.

So should we conclude that Brexit has been an economic nonevent? That would still be a hasty judgement to reach.

The adverse impact of higher inflation on consumer spending is likely to play out with a lag and the outlook for capital spending is weak. Ratings agency S&P warned today that it was too early to celebrate based on the August data, which “has no bearing on the cloudy longer-term outlook for the UK economy.”

However, we believe it would be wrong to dismiss the recent data. It may imply that, rather than a short sharp shock, we’re looking at a much softer, but more persistent, drag on growth until the Brexit fog has lifted.

Pessimism Misplaced?

Nonetheless, the evidence currently available to us suggests that the dire warnings issued by the Bank of England and others before the referendum may have been misplaced.

It also makes the MPC’s aggressive policy response look a bit hasty: recent data suggest that second-half growth could well be materially stronger than assumed by the Bank.

Of course, the Bank isn’t about to admit this. Indeed, Governor Mark Carney has already claimed that the MPC’s prompt actions have contributed to the rebound in confidence—and there may be a kernel of truth in this.

But one thing is clear: unless there are renewed signs of weakness, we believe that prospects for further monetary-policy easing this year are now much diminished. And this, in turn, should take some downside pressure off the pound.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.