Mind the Brexit gap

Dünya Executive - - REPORT - Holger Schmieding, economist, Berenberg

Changes in underlying fundamenta­ls often show up in confidence measures before they affect lagging variables like real wages. Consumer expectatio­ns increased strongly from 2012 until 2014 as the UK economy rebounded from the 2010-2011 soft patch linked to the crisis in the neighborin­g Eurozone. Boosted by the falling oil price in 2015, real wages continued to rise a little thereafter despite a downturn in expectatio­ns. By late 2015, both variables had started to jointly decline as global worries mounted. The

UK’s Brexit vote in 2016 caused further falls as uncertaint­y clouded the outlook and rise in inflation from the 15 percentplu­s sterling depreciati­on squeezed real wages. Beginning in 2017, however, a gap has emerged. Although real wages are up, household expectatio­ns are down on the back of persisting Brexit worries. Real domestic consumptio­n has expanded at an average annual rate of 2.1 percent since the Brexit vote, compared to 2.6 percent in the two years before the referendum. Real retail sales growth has slowed only modestly to 3.1 percent yoy from 3.8 percent over the same period. Autos demand has softened badly since the Brexit vote. New car registrati­ons declined 3.7 percent on an annual basis in the year to April. The outlook remains soft. This is no surprise. When consumers are uncertain about the future, they shorten their spending horizons – they maintain day-to-day spending but shy away from big purchases. UK households have mostly managed to weather the initial Brexit shock well. However, a slide in expectatio­ns and weak demand for some big ticket items carry a clear message. A hard Brexit would raise uncertaint­y and, most likely, squeeze real wages via a spike in inflation due to a drop in the exchange rate. In this case, household demand could weaken badly. Consumptio­n makes up nearly 70 percent of UK GDP. Where households go, the economy usually follows. A hard Brexit (35 percent risk) presents the single biggest risk to the outlook for domestic consumptio­n and the broader UK economy. (May 31)

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