Anti-Brexit protester Steve Bray (L) and a pro-Brexit protester argue as they demonstrate outside the Houses of Parliament in Westminster on January 08, 2019 in London, England.
LONDON — As evidence mounts of the long-term harm being inflicted on the U.K. economy by Brexit, the government is coming under pressure to acknowledge the elephant in the room.
Despite criticizing the Conservative government’s fiscal plans as the U.K. economy faces a recession and the sharpest fall in living standards since records began, the country’s main opposition Labour party on Tuesday ruled out a return to the EU’s single market or customs union if it wins the next general election — due no later than January 2025.
Labour leader Keir Starmer told a business conference that the party would instead “make Brexit work,” but economists have suggested that either or both of these measures would help to cushion the blow to the country’s long-term economic growth prospects.
The government has avoided addressing the impact of former Prime Minister Boris Johnson’s Brexit deal, with ministers attributing the country’s economic headwinds solely to the energy crisis arising from Russia’s war in Ukraine, and lingering effects from the Covid-19 pandemic.
However, the OECD forecast on Tuesday that only Russia would suffer a bigger economic contraction than the U.K. in 2023 among the G-20 (Group of Twenty) leading developed and developing economies. The 0.2% expansion projected in 2024 is the joint-weakest alongside Russia.
The U.K.’s growth prospects are lower even than Germany, whose economy is uniquely exposed to higher energy prices owing to its reliance on Russian gas imports. The OECD said “lingering uncertainty” alongside higher costs of capital would continue to weigh on business investment in the U.K., which has fallen sharply since Brexit.
The U.K.’s independent Office for Budget Responsibility (OBR) has offered a bleaker outlook, projecting a 1.4% GDP contraction in 2023, even as the Bank of England and the government are forced to tighten monetary and fiscal policy to contain inflation and prevent the economy overheating.
The OBR said in its economic and fiscal outlook last week that its trade forecast reflected an assumption that Brexit would result in the U.K.’s trade intensity (an economy’s integration with the world economy) being 15% lower in the long run than if the country had remained in the EU.
Trade intensity plunging
In May, the OBR estimated that the U.K.’s new terms of trade with the EU, set out in the Trade and Cooperation Agreement (TCA) that came into effect on Jan. 1, 2021, will reduce long-run productivity by 4% relative to the previous trajectory had the U.K. remained in the EU.
The Bank of England‘s Monetary Policy Committee issued a similar projection, and former BOE policymaker Michael Saunders told CNBC Monday that a key driver of weakness in the U.K. economy is reduced trade intensity due to Brexit, leading to lower productivity growth.
Saunders argued that there is “abundant evidence” that increased trade intensity — or greater openness to trade on both exports and imports — raises productivity growth.
“The U.K. has increased trade barriers with Europe and trade deals that have been done with other countries are largely just maintaining the status quo of trade with third countries — there’s been no significant net increase in trade intensity with non-EU countries,” he said.
“So the overall net effect has been a significant reduction in the U.K.’s trade intensity, which you can see in the big drop in both imports and exports as a share of GDP since 2019 compared to the trends in other advanced economies and compared to the trends that we saw in the preceding years.”
U.K. trade as a percentage of GDP has fallen from around 63% in 2019 to around 55% in 2021, while domestic productivity growth is also sluggish. Both the Bank of England and the OBR estimate that the U.K.’s potential output has fallen outright since the fourth quarter of 2019, and will endure anemic growth through the next few years.
New York-based Kroll Bond Rating Agency downgraded the U.K. even before former Prime Minister Liz Truss’ disastrous mini-budget in September sent bond markets into a tailspin.
Ken Egan, director of European sovereign credit at KBRA, told CNBC last week that Brexit marked a “turning point” for the U.K. as it gave rise to several structural weaknesses in the economy.
“Part of the reason for our downgrade was a longer term view that Brexit has had and will continue to have a negative impact on the U.K. from a credit perspective, in terms of everything from trade to government finances to the macroeconomic side of things.”
KBRA, like the OBR, Bank of England, International Monetary Fund, OECD and majority of economists, believes growth will be lower over the medium term as a result of Brexit.
“Trade has already suffered, the currency has weakened but we haven’t seen the offsetting improvement of trade, investment has really been the weak point since Brexit, business investment has really deteriorated quite sharply,” Egan explained.
“If you compare inflation in the current dynamic to the rest of the world, core services, core goods inflation in the U.K. seems to be a lot higher than the rest of Europe. It’s that idea that even if the energy crisis was over tomorrow, you’d still have these stickier inflation pressures in the U.K.”
Public mood shifting
Saunders said that while part of the deterioration since the fourth quarter of 2019 was down to the coronavirus pandemic, Brexit also had a part to play as increased trade barriers with the EU for firms since the start of 2021 stymied activity.
“If you don’t want to reverse Brexit fully, you can still go for a softer Brexit than the U.K. chose to do,” he suggested.
“The U.K. went for pretty much the hardest of hard Brexits and that was a choice, we could have left the EU but gone for a form of Brexit which would have put many fewer barriers in the way of trade, trade intensity would have suffered less, productivity would suffer less over time.”
New Prime Minister Rishi Sunak’s government is expected to pursue friendlier relations with the EU than either of his predecessors, Boris Johnson and Liz Truss. However, both the Conservatives and Labour have ruled out any return to EU-aligned institutions for fear of disenfranchising voters in key pro-Brexit constituencies.
Yet recent polling suggests that the public mood may have begun to turn. A frequent YouGov survey earlier this month showed that 56% of the population said Britain was “wrong” to vote to leave the EU in 2016, compared to 32% who said it was the right call.
The 24-point deficit was the largest in the series dating back to 2016, and almost one-fifth of Leave voters now believed Brexit was the wrong decision, which was also a record.
French Economy Clings On to Growth as Energy Concerns Mount
(Bloomberg) — The French economy looks set to make it through the end of the year without a decline in output, even as business leaders are concerned about the increasing impact of surging energy prices on their activity.
A monthly survey of 8,500 companies by the Bank of France published on Thursday indicated a 0.1% expansion in the fourth quarter after activity improved more than anticipated in all sectors in November. Services are expected to grow again this month, while industry stabilizes and construction declines.
“Despite a very uncertain environment marked by a convergence of large-scale external shocks, activity is still resisting overall,” the central bank said. Its longer-term projections published in September assumed no growth in the final three months of 2022.
Read more: Bank of France’s Gloomy Outlook Casts Doubt on Macron’s Plans
The assessment is relatively upbeat compared with an average forecast from analysts for France to finish the year with a 0.2% quarterly contraction. S&P Global’s purchasing managers’ index for November indicates a recession is already underway in the 19-nation euro area.
The Bank of France’s survey also showed supply difficulties eased last month, reaching the lowest level in industry and construction since it started gauging frictions in May 2021.
Still, the central bank’s measure of the impact of surging energy prices points to greater headwinds early next year. Of the business leaders surveyed, 24% said the energy crisis is already having a significant impact on activity, while 35% see a hit in the next three months.
China’s Economy Is In for a Bumpy Ride as Covid Zero Comes to an End
(Bloomberg) — Three years after the first case of Covid-19 was reported in Wuhan, Chinese policymakers must now grapple with how to live with the virus while keeping the economy growing fast enough to stave off public anger.
With the Covid Zero policy being rapidly dismantled, the threat of economic disruption remains high. Infections are likely to surge, forcing workers to stay home, businesses may run out of supplies, restaurants could be emptied of customers and hospitals will fill up. Even though there’s optimism the economy will recover as China opens up to the rest of the world, the next six months could be particularly volatile.
Goldman Sachs Group Inc. expects below-consensus economic growth in the first half of next year, saying the initial stages of reopening will be negative for the economy, as was the experience in other East Asian economies. Morgan Stanley predicts China’s economy to remain “subpar” through the first half of next year. Standard Chartered Plc said growth in urban consumer spending will still lag pre-pandemic rates next year given the hit to household incomes during the pandemic.
The economy was already in bad shape this year because of the Covid outbreaks and a property market crisis. While China’s zero tolerance approach to combating infections has kept infections and deaths relatively low for most of the pandemic, the rapid spread of the highly infectious omicron variant exposed the challenges of maintaining strict controls. From snap city-wide lockdowns to almost-daily Covid tests, the restrictions have taken a heavy toll on people’s lives and the economy.
That discontent manifested in mass unrest at the end of last month. People in Beijing, Shanghai and elsewhere started to reject demands for quarantines or lockdowns of their housing estates, and between Nov. 25 and Dec. 5, at least 70 mass protests occurred across 30 cities, according to data compiled by think-tank Australian Strategic Policy Institute.
Authorities have moved to quell public anger by relaxing some Covid requirements around testing and quarantine — although the sudden and confusing changes to the rules over the past few weeks have injected more uncertainty about the economy’s outlook.
Here’s a deeper look at the economy’s downturn and the challenges it faces as China exits Covid Zero.
People have been cooped up in their homesChina’s cities have been hit hard by Covid restrictions, with mobility across the country’s 15 largest cities plummeting in recent months, according to congestion data released by Baidu Inc.
Major hubs are showing strain, including the capital Beijing, as well as Chongqing and Guangzhou. Trips there have plunged in recent months below levels in previous years, according to subway data compiled by Bloomberg.
Few have borne the brunt of China’s Covid Zero policy more than the financial hub of Shanghai, a major epicenter for recent protests. After a two-month lockdown this year to tackle a major outbreak, China’s richest city is still struggling to get back up off its knees.
Malls have seen a surge in vacancies, consumer spending has plunged, and spending in areas like food and beverages has been depressed, mirroring the national trend.
Lack of spending has hit the economy hardCovid restrictions have battered the economy, with consumers pulling back on spending and business output plunging. Retail sales unexpectedly contracted 0.5% in October from a year earlier, with economists surveyed by Bloomberg predicting an even worse outcome of a decline of 3.9% in November.
The government is expected to miss its economic growth target of around 5.5% by a significant margin this year. The consensus among economists is for growth of just 3.2%, which would be the weakest pace since the 1970s barring the pandemic slump in 2020.
With onerous testing rules, flare ups in holiday spots, and official advice discouraging travel, holidaymakers have stayed home, adding a further drag on retail spending. Tourism revenue declined 26% to 287 billion yuan ($40.3 billion) over the week-long National Day holiday in October compared to the same period last year. Flight travel also dropped to its lowest levels since at least 2018.
Youth unemployment is near a record high
That’s all combined to drive growing economic malaise among the country’s youth, with the unemployment rate among 16-24 year-olds soaring to a record high of about 20% earlier this year. Joblessness among young people is more than triple the national rate, with many graduates struggling to find work in the downturn, especially in the technology and property-related industries.
Unemployment will likely get worse next year, when a new crop of 11.6 million university and college students are expected to graduate, adding to pressure in the labor market. Factories are still struggling to cope with Covid outbreaks
So far during the pandemic, the industrial sector has held up better than consumer spending since factories were protected from Covid outbreaks and global demand for Chinese-made goods was strong. That’s changing now.
Export demand is plummeting as consumers around the world grapple with soaring inflation and rising interest rates.
The disruption at a major assembly plant in Zhengzhou for Apple Inc.’s iPhones and violent protests there last month also show the damage that outbreaks can have on production.
The housing market crisis continues to simmer
China’s ongoing real estate slump has also been a source of unhappiness for homebuyers. The property market, which has long been a major driver of the country’s economy, is in its worst downturn in modern history, with sales and prices plummeting. Cash-strapped property developers struggled to finish building homes, prompting mortgage boycotts by thousands of buyers in the summer.
Despite authorities introducing a spate of measures recently to help make borrowing easier and ease tight cash flows for developers, the economy’s downturn and lack of confidence mean the housing market continues to be depressed. The slump is not expected to end soon, with Bloomberg Economics expecting a 25% drop in property investment in the coming decade.Local governments are struggling to fund their spending
Government finances have come under severe pressure as the economy slumped. Land revenues have plummeted and local governments have had to boost spending on Covid control measures. The broad measure of the fiscal deficit in the first 10 months of the year is nearly triple the amount it was in the same period last year.
Relaxing testing and quarantine rules will help ease pressure on local government finances. However, it remains to be seen how far and fast authorities will go in dismantling Covid Zero if a surge in Covid cases puts strain on the healthcare system, a likely outcome given that a significant portion of the country’s elderly and vulnerable population are still unvaccinated or lacking booster shots.
–With assistance from Kevin Varley, Jin Wu, Danny Lee and Fran Wang.
The US Fed’s Balance Sheet Shows What’s Happening To The Economy
The mother of all charts is below. This is the Federal Reserve balance sheet history straight from their website:
This is where the world’s inflation comes from. Not all, of course, because central banks around the world have done the same. In goes new money and up goes the price of stuff. Now if there is less stuff, then up goes the price even more. However, without new money prices cannot rise across the board, inflation is always about money supply.
This is why the Fed is reining it in. Down goes money supply, down goes asset prices.
Now there is one modifying factor. If you pump new money into an economy and that money goes to drive up the prices of illiquid assets, then the inflationary impact will be in those illiquid assets and the new money will be locked up there and will only dribble into the “real economy.” Let’s say you pump in money and make it easy to be grabbed by people buying houses or stocks but make it hard to be grabbed by people buying groceries, well then up will go the price of houses and stocks but groceries will not be that much affected. The lucky (rich) folk with the stocks and house will get much richer and the people who need to buy groceries will get left behind somewhat but at least there won’t be runaway inflation outside of stocks and houses. Woe betide an economy that hands out money to people to buy groceries because boy is everyone in for a bout of inflation then.
Ring any bells?
So to get prices under control you have to drain money from the system because when there is too much in the wrong places it starts rushing around bidding up the price of everything.
There is too much money in the system and that money is parked and it’s parked at the Federal Reserve where banks who can’t use a big chunk of this new money have kind of handed it back to the Federal Reserve to look after. That is the reverse repo which has gone out of whack with all the new money magicked up to bridge the pandemic.
Here is a chart of it:
Note how it matches the Fed balance sheet in character. This money is a bulwark for the banks if things get tricky as they can pull this cash out and back into play in the real economy, but in normality it would be down at 2014-2018 levels if there was just about the right level of money in the system. The Fed will feel there is plenty of room to tighten while these balances are high because if banks need liquidity, there it is.
This is where the big call lies. If banks were to say to the Fed, nope we aren’t going to lend to anyone but you and turn the real economy into a credit desert while damming up the cash with the Federal Reserve then there is no hope of a “soft landing.” If the money stays in the system as is then inflation should run its course and the new money supply would match new price levels, which wouldn’t be so bad, but the trouble is government fiscal deficits would then necessitate further money supply increases creating further inflation which could only be combatted with more interest rate rises, causing a vicious circle of high inflation and stagnation. That is what happen in the 1970s…
But that is all “what if.”
The real map is the progress of these two charts. If these balances fall without much drama then all is working out well, but if tightening starts to badly disrupt the economy without these levels falling materially then it will be a signal to take cover.
The institutions think inflation is about to fall sharply and that then new QE will restart. I say ‘good luck with that.’ However, these charts will provide the guidance necessary to judge the likely outcome ahead.
For me there needs to be a capitulation to define the new beginning we are entering and that hasn’t happened yet.
Once again these charts will give a solid indication of what’s up next.
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