Before the uncertainty surrounding the EU referendum vote and then shock related to a leave vote, the UK economy was already slowing. Growth, though solid, was unbalanced and largely concentrated on consumer spending, which in turn was dependent on growth of real wages. Household debt remained high, productivity and business investment low, and the public finances continued to be squeezed. Furthermore external factors were continuing to depress the economy and above all exports.
The reaction in the financial markets has been relatively modest compared with the expectations of the doomsters. The most obvious one has been the depreciation of sterling, but its fall to below US$1.30 at one point is likely to be a net benefit for the economy: Growth and above all the balance of growth will improve, though the prices of petrol and certain foods will inevitably rise. Nevertheless, I see this as like 1992, when the economy did very well from the plunge in sterling after we exited the exchange rate mechanism.
Also market rates have fallen, partly due to the expectation that base rates will be cut but also because of safe-haven effects. That 5-year gilt yields are around 0.3% is great news for reducing the cost of servicing the ever rising government debt burden (although this is having an adverse impact on already large pension deficits). The FTSE 100 is already back in positive territory, while the more domestically-oriented FTSE 250 has recovered the majority of its losses. However bank and construction shares remain sharply down indicating where the potential pain could be concentrated. Nevertheless, financial stability seems reasonably assured in the short-term at least aided by Bank of England action including pumping liquidity into the system and cutting bank's requirements for counter-cyclical capital buffers.
Regarding real data, the evidence of a slowdown comes mainly from confidence, sectoral and internet data. There have been a number of business and consumer confidence surveys released and they do suggest there has been an adverse impact. But so far this appears insufficient to imply a prospective recession. Moreover, these surveys often do give false readings of downturns or do not have an established track record of prediction. High frequency indicators tend to suggest that retail spending is holding up such as John Lewis' sales data. But there is evidence of delays in investment decisions and a reluctance to take on new staff at the moment. There are also clear signs of a slowdown in the housing market, with London house prices in particular no longer rising and sales taking time to time. The commercial property market is going through bad times, and banks have sharply cut lending to this sector.
But in reality there is a lack of hard macro data available so far to judge the impact. Monthly data will only be available for July from mid-August and the key GDP Q3 data is not out until late October. This indeed was a key reason (along with the monetary easing from the plunge in sterling and preference to keep limited ammunition in reserve) I believe for the Bank's monetary policy committee to leave base rates unchanged at 0.5% yesterday. Nevertheless expect a cut to 0.25% in August unless there are signs of things turning for the better perhaps because of the improvement in the political situation following the acceleration of the anointing of a new PM.
While many economists are predicting a recession in 2017, I believe that we should just be able to avoid such a situation with GDP still growing by some 1% next year after may be 1.75% this year. This will be aided by a slowdown in fiscal austerity, further monetary easing and reasonable progress in the Brexit negotiations. The German finance minister has already given a hint that there is plenty of room for negotiation in the trade-off between control of labour movement and access to the single market. Further out my positive vision regarding Brexit means I think we can see the return of 2% plus growth potentially as soon as 2018. The UK economy finds itself in a difficult situation but it is not one, for example,to compare with the global financial crisis of 2009.