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Chill of Brexit risk threatens UK’s economic spring

By GlobalCapital
22 Mar 2016

The pity of the uncertainty and volatility caused either directly or indirectly by the upcoming referendum is that it comes at a time when, after a number of false dawns, the UK economic recovery appeared to be gathering some staying power, reports Philip Moore.

The UK’s auto industry, which employs around 140,000 people, is doing rather well. According to numbers published by the Society of Motor Manufacturers and Traders (SMMT), production reached a 10 year high in 2015. Even more impressively, of the 1.59m cars that rolled off the production line in the UK last year, a record 77.3% were exported. 

With exports to Russia nose-diving by 70% last year and sales to China falling by 37.5%, the key driver of demand for British-built cars was Europe, where demand rose by 11.3%, lifting its share of UK car exports to 57.5%. According to a recent Morgan Stanley report, the UK operations of Nissan, Toyota, Honda and Jaguar Land Rover (JLR) now collectively export close to €10bn to Europe.

So it is not surprising that those in favour of Britain’s continued membership of the EU have warned about the dire consequences that would befall the auto industry in the event of a Leave vote in June’s referendum. Alan Johnson MP, who chairs the Remain campaign for the Labour Party, has warned that if Britain leaves the EU, its car manufacturers could be hit with annual tariffs of more than £1bn ($1.45bn).

Small wonder, too, that the SMMT is very clear about what side of the EU fence it sits on. Its chief executive, Mike Hawes, has described EU membership as “vital” for “future growth and jobs”.

This view has been echoed by the BMW Group, which owns Rolls-Royce and Mini, and contributes £1.2bn a year to the UK economy. In March, BMW left its 18,000 UK employees in no doubt about its attitudes to the referendum, infuriating those in the ‘Leave’ camp by warning that an exit could jeopardise jobs by increasing costs.

Perhaps surprisingly, few other auto manufacturers in the UK have been as ready as BMW to make public pronouncements expressing their opposition to Brexit, and none have suggested that they would consider upping sticks in the event of a Leave vote. Quite the reverse. Witness the announcement in February of a $280m investment by the luxury car manufacturer Aston Martin, which will create 750 local jobs in the small community of St Athan in South Wales. 

Granted, Aston Martin’s customer base is made up largely of price-insensitive buyers from outside the EU. Nevertheless, the choice of St Athan, which fended off competition from 20 or so locations scattered across the globe, is a notable vote of confidence in the UK economy. 

Unsurprisingly, the announcement was seized by the leader of the Welsh branch of the UK Independence Party (UKIP) as one in the eye for “Brexit scaremongers”.


Staying — whatever

UKIP has given an equally joyous — if slightly selective — response to the message from Burnaston in Derbyshire, where Toyota has churned out more than 3.25m vehicles since it began production in 1992. Its chief executive recently told The Financial Times that Toyota would continue to manufacture cars in Britain, Brexit or no Brexit.

Another key location for auto manufacturing in the UK is Sunderland, where Nissan Motor Manufacturing (UK) was established in 1986, throwing an economic lifeline to the depressed north-east of Britain. Nissan, which exported 80% of the 475,000 cars it produced in the UK last year, has been rather more outspoken than some other auto manufacturers about its views on Britain’s membership of the EU. 

“Our preference as a business is that the UK stays within Europe,” it announced in February. “It makes the most sense for jobs, trade and costs.”

Even Nissan, however, has given some encouragement to the ‘Leave’ campaign, saying that it remains committed to its existing investment decisions, and ruling out explicit support for any political campaign in the run-up to the referendum. Diplomatically echoing many other large manufacturing companies in the UK, it says that the in-out decision is a matter for the British public to decide. 

It’s easy to see why some auto manufacturers have been less vociferous supporters of the in-campaign than Prime Minister David Cameron, for one, will have hoped. As Morgan Stanley’s note explains, “from an automotive market perspective, Europe has as much if not more to lose than to gain from its access to the rich and large UK market, with over €30bn in annual export sales, and potentially €3bn-€4bn in UK earnings.”

This is perhaps one reason why the Confederation of British Industry (CBI) reports that “the majority — but not all” of its members want the UK to remain in a reformed EU. 

It is not just some of Britain’s largest companies that have embarrassed the Stronger in Europe campaign by contesting the view that Brexit would be a precursor to economic disaster. So too have some of the most respected individuals within the UK’s financial services sector. The fund manager Neil Woodford is among the most prominent of these. His firm’s paper on the economic impact of Brexit, commissioned by Capital Economics, raises questions about a number of assumptions made by the ‘Remain’ lobby, notably on trade and tariffs. 

“Contrary to the claims of many authors and commentators,” this observes, “it is probable that the impact of Brexit on trade would be relatively small. Moreover, it is certainly possible that leaving the EU would leave the external sector better off in the long run, if Britain could use its new found freedom to negotiate its own trading arrangements to good effect.”

This is by no means an isolated view, and the continued ambivalence of so many pockets of UK industry will alarm Cameron, who has staked his political future (recklessly, some believe) on an endorsement of EU membership by the British public in June’s referendum. 

It will also alarm City-based economists, the majority of whom regard Brexit as a recipe for short-term economic disaster and longer-term uncertainty, with negative implications for the UK’s sovereign rating. Standard & Poor’s (S&P) sounded this particular warning long before the June referendum was officially announced. 

Assigning a Brexit-induced negative outlook to the UK’s rating last summer, S&P cautioned that a departure from the EU would raise “questions about the financing of the economy’s large twin deficits and high short-term external debt”.

Fitch has issued a similar warning, saying that a vote to leave would put pressure on the UK’s AA+/stable sovereign rating “due to near-term policy uncertainty and risks for medium-term growth and investment”.

Big risk, little reward?


More recently, unease about the possible ramifications of a Leave vote has led a growing number of economists to express concerns about the impact of a Brexit, and about the unappealing options that will confront Britain if it drops out of the EU. 

“Big risk, little reward”, is how BlackRock summarises a British departure from the EU. Its analysis describes the likely options for Britain in a post-Brexit world as ranging from being a non-starter (in the case of a Norwegian-style deal), to unacceptable (à la Switzerland), unattractive (Turkish trade), and difficult (a UK tailored deal).

HSBC’s analysis of the probable impact of the UK rejecting EU membership is bleaker still. “Following a vote to leave, we think uncertainty could grip the UK economy, triggering a potential slowdown in growth and a collapse in sterling,” says HSBC in its 48-page assessment, entitled Brexit Strategies.

Specifically, HSBC warns that in the event of Brexit, its central case is that sterling could fall by 15%-20% against the dollar, pushing it down towards levels last seen in the 1980s. With sterling also moving towards parity with the euro, inflation could rise by as much as 5pp, while growth could be 1pp-1.5pp lower. This would roughly halve HSBC’s current 2017 growth forecast of 2.3% as real incomes are eroded leaving households with less to spend.

It is not just the UK economy that would suffer in the event of a Brexit. A recent Morgan Stanley report warns that “the economic implications for the eurozone could be significant”, adding a Leave vote could trigger a “sharp deterioration” in sentiment in Europe in late 2016. 

Lombard Street Research (LSR) has also warned about the impact of a Brexit on the eurozone, saying that it could release the “exit genie”. In other words, attention would shift to the danger of a Spexit, Itexit or Frexit, any of which would probably be ruinous for the single currency. 

Just as well, then, that the majority of economists and analysts continue to report that they believe the British public will choose to remain in the EU. So, too, do many of the most influential investors. All respondents to a recent Aviva poll of multi-manager investors, with £2tr under management between them, indicated that they expect the Remain campaign to defeat the Leave supporters in June’s referendum.

A self-fulfilling prophecy?

On the surface, this would appear to be positive news for the economy, although the sharp slide in sterling since the announcement of the referendum in February suggests that there are plenty of market participants who are betting against a Remain vote. 

This, of course, may mean that the negative economic impact of Brexit uncertainty becomes a self-fulfilling prophecy before a single vote has been cast in June’s referendum. Already, a number of analysts are warning that the depreciation in the UK currency is generating upside risks to their largely benign inflation forecasts. That may in turn nudge the Bank of England towards tightening monetary policy sooner rather than later, which may in turn have an impact on investment and the housing market.

The pity of the uncertainty and volatility caused either directly or indirectly by the upcoming referendum is that it comes at a time when, after a number of false dawns, the UK economic recovery appeared to be gathering some staying power. 

The IMF certainly liked what it saw when it was preparing its most recent scorecard on the UK economy in February. “Considerable progress has been achieved in the post-crisis repair of the UK economy,” the IMF reported. “Private-sector indebtedness has been reduced, the financial sector regulatory framework has been overhauled, the fiscal deficit has been cut in half, and the employment rate has reached a record high. With the output gap now nearly closed, growth is expected to average near its potential rate of around 2.25% over the medium term, with inflation rising slowly from its current low levels to the 2% target by end-2017.”

This broadly benign prognosis for the UK economy is shared by the majority of economists, although most have been notching down their projections for growth in response to what Chancellor George Osborne recently described as “storm clouds” gathering in the global economy. This inclement weather has been caused by several factors, led by concerns about Chinese growth, the sclerotic performance of the eurozone economy and the deflationary impact of the slump in the oil price. 

This turbulence in the global economic weather has limited Osborne’s options for succeeding in running a fiscal surplus from 2019-20 onwards. Small wonder that the Institute of Fiscal Studies (IFS) called the challenge created by the Osborne’s “very inflexible target” as a “precarious balancing act”.

In March’s Budget, Osborne took a step on to this tightrope, announcing a package of politically risky public service cuts worth £3.5bn annually, and changes in personal and corporation tax rates. 

These challenges are in keeping with the performance of the UK since the downturn of 2008, which has repeatedly seen the country’s economy take two steps forward and one back. In a recent speech, the Bank of England’s deputy governor for financial stability, Sir Jon Cunliffe, described the UK’s economic recovery since 2008/09 as a “slow healing story”. Indeed, during the 2016 Budget, Osborne said the UK’s economy will grow 2% during 2016, rather than 2.4% he announced in November 2015.

Each nascent recovery since then, Cunliffe said, has been hit by an unfortunate external event — be it the euro crisis, weakness in emerging markets or the deflationary shock from the oil price collapse. The net result, said Cunliffe, has been the slowest recovery in Britain’s modern history — slower even than the recovery from the Great Depression.

The good news is that the Bank of England sees several signs of strength in the economy. These include consumer confidence at close to record levels, business investment strengthening, housing market transactions picking up and credit growing roughly in line with GDP. 

But as Cunliffe conceded in his February speech, improvement in some areas continues to weigh in below expectations. Perhaps most unsettling has been the reappearance of Britain’s productivity bogeyman. Having picked up in the middle of 2015, productivity growth dropped back to a tepid annual growth rate of about 25bp by the end of the year. Nor is the Bank of England now counting on much of a turnaround in the foreseeable future. 

According to Cunliffe, the Bank is no longer expecting any catch-up in the productivity growth lost since the 2008 recession. Instead, it is forecasting a recovery to just 1.8%, compared with 2.7% between 1950 and 2007, and 2.2% in the decade before the crisis.

For the UK economy, this story is all too familiar. Sajid Javid, secretary of state for business, innovation and skills, put it into perspective in a recent speech, noting that “in stark terms, it now takes a worker in the UK five days to deliver what his or her counterparts in Germany can deliver in four”.

This is a wretched indictment, and the comparison with the US is equally unflattering. According to the government, if the productivity gap that exists between Britain and the US could be closed, it would increase GDP by 31%, which would equate to about £21,000 per annum for every household in the UK.    

UK and China — the golden decade?

With growth slowing in the eurozone and uncertainty mounting about Britain’s future trading links with the EU, cementing economic relations with fast-growth emerging markets such as China is logical. But don’t expect miracles overnight — the UK still exports more to Ireland than it does to China and Hong Kong combined.


When Chancellor of the Exchequer George Osborne first visited Shanghai more than 20 years ago he did so as a backpack-carrying student. These days, he gets somebody else to carry his bags, not least because his Chinese itineraries aren’t restricted to the most populous eastern cities of Shanghai and Beijing, as those of most official visitors are. 

When he led a British delegation to China in September, Osborne became the first British government minister ever to venture into the northwestern province of Xinjiang. Osborne’s visit to the province’s city of Urumqi was not entirely without controversy, given concerns raised by human rights activists about a security crackdown on China’s minority Muslim population, a large concentration of which lives in Xinjiang. 

A glass-half-full interpretation of Osborne’s visit, however, is that the geographical location of the province gives it a pivotal role in China’s ambitious One Belt, One Road plan. As this is designed to create jobs and build much-needed infrastructure along the old Silk Road trading route between China and Europe, anything that encourages rising investment flows between Xinjiang and the rest of the world is to be applauded. As Osborne made plain when he visited Urumqi, he is determined to ensure that UK companies play a key role in helping to support the Silk Road Economic Belt project. 

More broadly, the UK’s commitment to supporting the development of the Chinese economy was reflected in 2015 with the announcement by the government of the £1.3bn ($1.88bn) Prosperity Fund aimed at “promoting economic reforms and growth while supporting the delivery of China’s 13th five year plan (2016-20).” Specifically, this fund is designed to support initiatives such as financial sector reform, energy and resource security and clean and low carbon transition. 

Osborne’s preparedness to go the extra mile in cultivating economic friendship with China were certainly welcomed by British private sector companies building relationships with Chinese investors beyond Beijing and Shanghai. The Urumqi-based Hualing Group, for example, is one of the investors in three major property projects led by the UK’s Scarborough Group (SGI) in Manchester, Sheffield and Leeds with a collective gross value of £1.2bn.

For companies such as SGI, it has been especially heartening to see trade as well as transportation links growing between China and the north of Britain. One of the most significant milestones in the development of these links will be the launch in June of the first direct flight between Manchester and Beijing. Operated by Hainan Airlines, it has been reported that this service — initially running four times a week — will generate some £250m in economic benefits to the UK. 

Rongrong Huo, global head of China and RMB business at HSBC in London, echoes business leaders’ appreciation of the legwork that Osborne has put into promoting Britain, as well as the Northern Powerhouse project, in China. 

“All of China’s trading partners organise regular visits to China,” she says. “But perhaps few have done so in such a business-oriented, economics-driven way as Chancellor Osborne.”

Another visible indication of the burgeoning economic relationship between London and Beijing was the state visit to Britain last year of President Xi Jinping, which was the first Chinese presidential visit to the UK for 10 years. That visit, Osborne said at the time, heralded a “golden decade of co-operation” between the two economies which — according to the government’s masterplan to bolster exports — will make China Britain’s second largest trading partner by 2025.


Notable progress has already been made towards this ambitious target. As Osborne said when he visited China last September, in the last five years Britain’s goods and services exports to China have almost doubled, making China the UK’s sixth largest export market. “If we maintain our current market share of trade with China, UK exports could be worth over £30bn by 2020,” said Osborne. “If China rebalances more significantly, these opportunities could be even greater.”

With growth slowing in the eurozone and uncertainty mounting about Britain’s future trading links with the EU, cementing economic relations with fast-growth emerging markets is clearly towards the top of the UK government’s to-do list. But the potential of these markets needs to be seen in perspective. 

As PriceWaterhouseCoopers (PwC) comments in a recent update, the UK still exports more to Ireland than it does to China and Hong Kong combined. “In the future,” says PwC, “we expect this to change, but it will be a slow process — even by 2030, the share of UK exports going to the largest seven emerging economies (the E7), led by the Asian giants of China and India, will still only be around 13%, up from 9% now.”

Views are divided on how a vote to leave the EU would impact trade relations between Britain and China. Those who champion continued membership of the EU argue that it may take the UK years to negotiate bilateral trade agreements with economies such as China and India. 

But as a recent Deutsche Bank report observes, leaving the EU may give Britain flexibility to negotiate trading agreements more quickly and efficiently. After all, in 2014 Switzerland’s free trade deal with China entered into force after just three years after the first round of negotiations kicked off in April 2011. “This compares with the EU where a number of years of trade negotiations with China have failed to produce a free trade agreement covering the EU in [its] entirety,” notes the Deutsche Bank report. 

Perhaps more to the point, the trade agreement is working. On the occasion of the first anniversary of the agreement, in June 2015, Switzerland’s State Secretariat for Economic Affairs (SECO) noted exports to China had risen by 3% during the previous year. This compared with an increase in exports to the rest of the world of just 0.4%. Imports from China, meanwhile, rose by 4%, while those from other countries fell by 3.9%.    

By GlobalCapital
22 Mar 2016