Uncertainty and fear generated following the June 23 vote means sentiment towards the economy has been impacted, writes Jim Power
SENTIMENT is the most important driver of economic activity. If people and businesses lack confidence about the future or are faced with immense uncertainty, the natural response is to postpone spending or investment decisions and do whatever it takes to guard against potential risks actually materialising. The UK in recent months has provided a very good template for how this works.
Before and after the Brexit referendum, those on the ‘leave side’ argued that it would not fundamentally damage the economy, in the longer term at least. That may turn out to be case, although I doubt it somehow, but it is clear the uncertainty and fear created by the vote to leave is now very real and is having a significant short-term impact.
Since the vote, sentiment towards the UK economy has taken a serious hit, and that is now starting to feed through to economic activity. It is probable that we have not seen anything yet.
UK economic growth in the second quarter proved more resilient than might have been expected given the uncertainty that prevailed ahead of the Brexit vote. GDP expanded by 0.6% during the quarter and was 2.2% ahead of the second quarter last year. However, most of the growth occurred at the beginning of the quarter and weakened considerably towards the end of the period. Indeed there is ample evidence to suggest activity has weakened further in the third quarter, with growth for July looking quite weak.
However, most of the growth occurred at the beginning of the quarter and weakened considerably towards the end of the period. Indeed there is ample evidence to suggest activity has weakened further in the third quarter, with growth for July looking quite weak.
For example, the composite purchasing managers’ index (PMI) of services and manufacturing fell to 47.5 in July from 52.5 the previous month. A reading below 50 signifies a contraction in activity. It would need to fall to around 40 to signify outright recession in the economy, but the latest readings are certainly suggesting a marked slowdown in activity.
The latest forecast published by the Bank of England has shown the biggest downgrade to growth in 20 years. This is saying something, given the global crisis that prevailed after 2008 and the dramatic hit that the UK, along with most other global economies, took.
This downgrading of growth is really reflecting the obvious deterioration in sentiment and the uncertainty that now prevails about how the EU extraction process might work.
The UK authorities are clearly taking the risks seriously and are reacting aggressively to the possible near-term consequences of Brexit, which it sees as being quite negative. At the August monetary policy committee meeting last week, the Bank of England cut its base rate to 0.25%; announced that it will buy £60bn (€69bn) of government bonds over six months and £10bn of corporate bonds over 18 months; and to lend as much as £100bn to banks to make sure the stimulus measures reach the real economy.
This is a pretty aggressive response from the BoE. The fact that official interest rates are now at historic lows, and could fall further, and that quantitative easing is being ramped up, shows just how seriously the normally conservative central bank is taking the Brexit risks. It is inevitable the government will have to step up to the plate and signal an easing of fiscal policy.
From an Irish perspective it is good to see the UK authorities taking the risks so seriously, and obviously being prepared to do whatever it takes to prevent recession. There will inevitably be a slowdown in the UK economy, but if recession could be avoided, that would represent some good news for Ireland.
However, one of the consequences of the more aggressive monetary policy approach is that sterling continues to take a hit and is now pushing towards 86p against the euro. This currency trend is very bad news for Irish indigenous exports and for UK tourism into Ireland.
On the other hand, imports from the UK will get cheaper and the UK will become a more attractive location for the Irish to visit.
It is possible that we could see the old cross-border shopping phenomenon raise its head over the coming months. Developments in the UK are and should be a major source of concern for Irish policymakers.
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