The Brexit economic ledger with 1 year to go

Pan Pylas, The Associated Press</span>
Published Thursday, March 29, 2018 7:21AM EDT
Last Updated Thursday, March 29, 2018 7:25AM EDT

LONDON -- Britain is a year away from leaving the European Union, potentially with no post-Brexit agreement with its biggest trading partner.

And Thursday marks the half-way point since Prime Minister Theresa May triggered the two-year process for the country's departure from the EU.

Brexit is potentially the most seismic change the British economy will have faced since the Second World War. It has caused massive volatility in the currency, eroded living standards but also given a boost to exporting businesses. And the future remains uncertain, with a range of post-Brexit scenarios still possible.

As the exit process hits half-time, here's a look at how this momentous decision has shaped the British economy and markets.

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LOWER GEAR

Before the referendum of June 2016 in which a narrow majority voted to leave the EU, the British economy had been one of the fastest-growing industrial economies for years.

Now, it's one of the slowest. It grew only 1.7 per cent in 2017 and is anticipated to expand at a similarly muted tick this year.

Brexit proponents would note that the predictions of recession made ahead of the vote, by authorities like the International Monetary Fund or British Treasury, failed to materialize.

There are numerous reasons why that is.

A drop of about 15 per cent in the pound's value after the referendum made exporters more competitive in international markets. Bank of England Governor Mark Carney says exporters have benefited from a so-called "sweet spot" -- being able to continue to trade in the tariff-free EU, but at a lower cost.

Also, somewhat ironically, much stronger growth in many countries in Europe, particularly among the 19 that use the euro currency, has shored up economic activity in Britain.

Given that the world economy is broadly healthier than at any time since the global financial crisis a decade ago, many think Britain would be doing a lot better were it not for the prospect of Brexit. Uncertainty over Brexit has hurt business investment and household spending has been hobbled by the rise in prices stoked by the lower pound.

"We think the U.K. economy should be growing almost twice as fast," said James Smith, developed markets economist at ING.

And that matters -- higher growth would likely mean more jobs, higher salaries and higher spending on public services.

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SO WHY HIKE?

One of the more unexpected developments since the Brexit vote is that the Bank of England is raising interest rates, in contrast to the European Central Bank, which is overseeing an economy that is growing -- and expected to grow over coming years -- at a faster clip.

In November, the Bank of England raised its benchmark rate by a quarter-point to 0.5 per cent, its first hike in a decade. It has also indicated that another similar hike is likely in May.

The main reason is to contain inflation, which from well below 1 per cent before the referendum has spiked to around 3 per cent as the lower pound pushed up the cost of imports. The bank, after all, is tasked with keeping inflation around 2 per cent.

Higher inflation has made households poorer as wages haven not grown as much.

Pay is now starting to pick up as unemployment has fallen to its lowest since the mid-1970s. That should boost retail spending in coming months but is also likely to mean inflation remains elevated, especially as oil prices are higher than they were a year ago.

Some economists think the Bank of England could raise rates three times this year, partly to give it more space to cut them again in the event the Brexit talks fall apart and the country crashes out of the EU on March 29, 2019 without a transition period.

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MARKET MOVERS

Whereas an economy is like a tanker and can take a long time to turn, financial markets are fleet of foot.

The pound was the early lightning rod for Brexit concerns, sliding after the vote to 31-year lows against the dollar below $1.20. Crucially, it also weakened against the euro -- about 40 per cent of Britain's exports go to the eurozone.

The pound has recovered in recent weeks, to around $1.40, partly because Britain and the remaining 27 EU countries have agreed on the outlines of a transition period after Brexit during which Britain remains in the tariff-free single market and customs union. But that transition period depends on reaching a final deal on what relations will be like after Brexit.

In the stock market, Brexit did not have as big an impact. In fact, investors in the broad FTSE All-Share index have enjoyed returns of up to 20 per cent. The reason is the lower pound helped exporters and boosted earnings for the many multinationals listed on the index that make most of their money outside the U.K. The economy's better-than-expected performance also helped assuage some investors' concerns.

However, Laith Khalaf, senior analyst at stockbrokers Hargreaves Lansdown, notes that a net 6.7 billion pounds ($8.4 billion) have flowed out of U.K. equity funds since the referendum. And local companies, particularly retailers, have seen their sales and share prices struggle as households cut down on spending.

"Outflows from U.K. funds were most pronounced following the referendum, and around the time of the general election last year, but negative sentiment towards the U.K. still prevails today," said Khalaf.

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