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Daniele Fraietta

Brexit: Short-Term Gain for Long-Term Pain?

by Daniele Fraietta | Dun & Bradstreet Editor

November 1, 2016 | No Comments »

Many critics of the UK’s decision to leave the EU say the reason people are not feeling the harmful effects of Brexit is only because Brexit has not happened yet. Pending the invocation of Article 50, an alarming underestimation of the negative long-term consequences of Brexit seems to have gradually superseded the bout of initial pessimism immediately after the June vote, as the UK economy posted stronger-than-expected GDP growth in Q3.

Indeed, a few metrics of economic performance suggest that the fundamentals of the economy are solid. The domestic output expanded by 0.5% quarter over quarter in the third quarter, a somewhat slower pace than Q2’s 0.7% growth, but faster than the average forecast of 0.3%. These results have also defied experts’ prediction of an economic recession following a Brexit vote.

Furthermore, retail trade growth accelerated over the quarter. Inflation is also gradually picking up on account of a cheaper pound, despite remaining well below the Bank of England’s medium-term target of 2%. September forward-looking indicators bode well for future economic activity, with Markit’s Purchasing Managers’ Index (PMI) for the manufacturing sector rising to its highest level since mid-2014.

Notwithstanding the current economic bonanza, Dun & Bradstreet predicts that the medium- to long-term economic impact of Brexit on the UK will be significant and negative. With the UK heading for a “hard” Brexit, D&B has downgraded the country’s risk rating from DB2c to DB2d (still just within the “low risk” category). We are also maintaining our “deteriorating” rating outlook.

Prime Minister Theresa May’s government is intending to prioritize immigration control and the supremacy of British law over EU law, so it is increasingly unlikely that the UK will maintain access to the EU’s common market once Brexit is eventually completed. This will increase the economic cost of Britain’s departure from the EU, with the UK being hit harder than the EU.

The possible loss of passporting rights, which currently allow UK-based banks to operate across the EU, is a major source of concern. Anthony Browne, chief executive of the British Bankers’ Association, recently claimed that Britain’s biggest financial institutions are already planning to leave the UK in early 2017, while smaller banks are preparing to relocate before the end of this year.

Goldman Sachs is allegedly making plans to transfer some 2,000 employees to a rival European city, and JPMorgan warned that as many as 4,000 jobs could be shifted out of the UK, according to its chief executive, Jamie Dimon. Nomura and Morgan Stanley are also among those that could move their operations out of the UK, although the latter recently denied a report that it had already decided to relocate 2,000 workers to either Dublin or Frankfurt.

Overall, Brexit can take a heavy toll on the UK financial sectors: Up to 70,000 financial jobs could be lost if Britain leaves the EU, according to the industry body TheCityUK.

While the domestic labor market and forward-looking indicators so far remain unimpressed by the looming hard Brexit, the pound is under pressure. In the last 12 months ending October 20, the pound lost 18% against the euro, 20% against the dollar, and a stark 32% against the yen.

EasyJet and Ryanair, together with several other UK-listed companies, are being affected by a weaker pound. EasyJet is expecting profits to fall by at least a mid-single-digit percentage in the second half of the year compared with the second half of 2015. Ryanair released its first profit warning since autumn 2013, lowering its growth forecast for the year by five points to 7% in October. Both companies blame their troubles on the fall in the value of the pound since the Brexit vote.

D&B doesn’t expect a recovery until the UK’s future relations with the EU are negotiated, something unlikely to be completed until the early 2020s.

Daniele Fraietta has been a D&B economist for more than two years. He currently covers some Western European countries, notably Italy, Greece, Spain, and Ireland. For D&B, Daniele has also developed the new econometric framework for commodity prices and exchange rates forecasting. He has an MSc in Economics from the University of Rome Tor Vergata, a Master in Business Administration from The Polytechnic University of Milan, and a Master in International Business from the Chapman College of Business.

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Photo by Ofer Deshe, used here under a Creative Commons license.

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