What the new Brexit delay means for UK manufacturers?
Capital spending and exports, the engines that drive the growth of British economy, entered lower gear due to weakening foreign demand and dragging uncertainty of Brexit. In these conditions, the economy begins to rely more and more on the main driver – consumption, which in turn depends on wage growth and consumer optimism – the channels through which shocks of aggregate demand enter the economy.
The fifth largest economy in the world expanded by only 1.4% in 2018, which was the worst performance in 6 years and data for the first quarter of 2019 show that the trend for slowdown will stay in place. “A sense of urgency” left British politicians with a Brexit postponement until the end of October, which will likely resume tedious process of “dragging the rope” between politicians. Lack of clarity about the access to EU single market in future drags on capital spending of UK firms.
Consumer spending grew last year at the lowest rate since 2012. Part of the slump came from Pound devaluation after the referendum, which boost price growth and put pressure on wages, hitting purchasing power of households’ incomes in Britain.
As inflation was suppressed and wages rose, the negative gap between these two variables favoured consumption thus boosting consumer confidence which supported household spending. Consumer spending and the government purchases made the biggest contribution to the growth of aggregate demand in 2018, while the capital expenditures and net exports slowed the rise
Normally, when expansion relies on household consumption, with muted action form other growth factors, it’s easy for the economy to lose momentum or to see how it changes sign: consumers are the last in turn to get and adjust to market signals, the only question is how soon this will happen. According to the head of the Bank of England Mark Carney, if the burden of expanding the economy lies on the shoulders of the consumer, we should start to “watch the clock.”
British firms have postponed plans to expand production since the announcement of the referendum in 2016. Now a negative outlook on investments is confirmed with a significant increase in inventories, as the companies are unlikely to expand without selling off the surplus. On the other hand, it can be preparations for a favourable Brexit outcome, in which companies will have access to a single market and will be able to support good level of sales. However, British firms will have to reduce production if Brexit drags on, in this case, a short-term surge in production activity observed now should be perceived as a “lull before a thunderstorm.”
The Bank of England for some time insisted on the need for a gradual increase in interest rates along with the emergence of certainty about leaving the UK from the EU. However, the fresh postponement is likely to force the Central Bank to repeat the mantra about patience again, especially in light of the deteriorating PMI from IHS / Markit, which to some extent well predicted monetary decisions
This, in turn, means negative Pound outlook as a result of BoE monetary decisions since the odds of its consistent disappointment become higher.