Mar­kets climb a wall of worry, and no-deal Brexit is the least of them

The Sunday Telegraph - Money & Business - - Business - JEREMY WARNER

It’s back to work this week af­ter the long Christ­mas break, and back there­fore to wor­ry­ing about Brexit. The odds of a no-deal Brexit have in­creased markedly since the col­lec­tive rasp­berry given by just about ev­ery­one to Mrs May’s con­tor­tion­ism, but there is no point in dis­ap­pear­ing down that par­tic­u­lar rab­bit hole again; the ul­ti­mate out­come re­mains un­know­able, and all anal­y­sis of its var­i­ous per­mu­ta­tions there­fore pretty much worth­less.

What is worth point­ing out, how­ever, is that Brexit is one of only three big un­cer­tain­ties hanging over mar­kets right now, and very prob­a­bly the least im­por­tant of them. The oth­ers are whether the US Fed­eral Re­serve will con­tinue to tighten in the face of a now ev­i­dently slow­ing global econ­omy, and the out­come of the deeply dam­ag­ing stand­off be­tween Amer­ica and China over trade.

To­gether, the un­cer­tain­ties amount to a kind of “triple witch­ing hour”, all con­verg­ing on the first quar­ter of this year. A be­nign out­come to all three would help stock mar­kets re­cover some of their mojo. A bad one, and the cur­rent cor­rec­tion would quickly turn into some­thing worse. Bear mar­kets in the ab­sence of an out­right re­ces­sion are quite un­usual, lead­ing some pun­dits to con­clude that what we are wit­ness­ing is more com­pa­ra­ble to Black Mon­day in 1987 and the Rus­sian debt cri­sis of 1998 than the much deeper sell-offs of the dot­com bub­ble and the fi­nan­cial cri­sis. In both cases, mar­kets soon re­bounded.

Has the Fed al­ready blinked? Cer­tainly that’s how mar­kets in­ter­preted re­marks on Fri­day by Jay Pow­ell, the chair­man, when he in­di­cated a will­ing­ness to shift path if the data war­ranted. We’ll see. We’ll also see whether the re­sump­tion of Us-china trade talks sig­nals an end to cur­rent ten­sions. And though a pro­longed tran­si­tion with neu­tral eco­nomic con­se­quences still seems the most likely form of UK with­drawal from the EU, we’ll see on that front too. If stock mar­kets con­tinue to re­cover while these matters re­main un­re­solved, with a now sharp down­turn in China pil­ing in on top, it will be against a wall of worry, mak­ing shares par­tic­u­larly vul­ner­a­ble to re­newed set­back.

De­val­u­a­tion div­i­dend?

The big­gest vic­tim of the vote for Brexit to date has been the value of ster­ling. Since the fi­nal quar­ter of 2015, when Brexit first be­came a dis­tinct pos­si­bil­ity, the pound has lost nearly a quar­ter of its value on a trade weighted ba­sis, mak­ing this one of the most se­ri­ous de­val­u­a­tions of the post-war pe­riod. You’ll be pleased to know, how­ever, that ac­cord­ing to true be­liev­ers in the eco­nomic ben­e­fits of Brexit, this is a good thing, as it ought, by mak­ing ex­ports cheaper and im­ports more ex­pen­sive, help in­duce a much-needed re­bal­anc­ing in the UK econ­omy to­wards net trade.

Un­for­tu­nately, there is as yet no sign of it. As a pro­por­tion of GDP, net trade is no higher to­day than it was three years ago when the de­val­u­a­tion be­gan. In­deed, the only ob­serv­able im­pact of the ex­change rate cor­rec­tion so far is that rel­a­tive to the rest of the world it has made us all no­tably poorer. This should in truth come as no sur­prise, since none of the pre­vi­ous de­val­u­a­tions have had any long-term im­pact on trade ei­ther. Down and down the pound has gone, but just as de­pen­dent on house­hold and govern­ment con­sump­tion for our growth do we seem to re­main.

Why is this? Why has the econ­omy failed to ad­just as you might ex­pect? Sa­muel Tombs, of Pan­theon Macroe­co­nomics, sug­gests three ex­pla­na­tions. One is that UK ex­porters are these days highly in­te­grated into in­ter­na­tional supply chains. The price ad­van­tage they gain from cur­rency de­val­u­a­tion in ex­port mar­kets is there­fore largely lost on the higher prices they pay for im­ported com­po­nents and raw ma­te­ri­als.

Sec­ond, Brexit un­cer­tainty is caus­ing Euro­pean cus­tomers to shun Bri­tish sup­pli­ers in favour of Con­ti­nen­tal al­ter­na­tives. Supply chains are be­ing re­worked in prepa­ra­tion for bar­ri­ers to trade.

And third, there has been sur­pris­ingly lit­tle im­port sub­sti­tu­tion, pos­si­bly be­cause Bri­tish man­u­fac­tur­ing has be­come so acutely hol­lowed out over the years that it is in­ca­pable any longer of re­spond­ing to in­creased de­mand. Brexit un­cer­tainty has also de­pressed busi­ness in­vest­ment, fur­ther crimp­ing the UK’S abil­ity to sub­sti­tute for im­ports.

The up­shot is that so far there has been zero gain from cur­rency de­val­u­a­tion, only cost. Sorry for the dis­heart­en­ing mes­sage, but if the ef­fect of a no-deal Brexit is to de­value the pound fur­ther, we are quite un­likely, in the medium term at least, to see a sil­ver lin­ing in the shape of a sig­nif­i­cant boost to net trade.

No-deal pre­pared­ness

An anony­mous civil ser­vant was re­cently quoted in The Daily Tele­graph as say­ing the Govern­ment had been less than truth­ful about prepa­ra­tions for a no-deal Brexit, pre­fer­ring in­stead to let Project Fear Mark III run wild in an ef­fort to con­vince MPS to back its hated With­drawal Agree­ment. In fact, he said, the coun­try is fully pre­pared with “very de­tailed plans”.

If so, I wish the civil ser­vice would spell them out. The fi­asco of Seaborne Freight – the ship­ping com­pany with­out any ships awarded a £14m Brexit con­tract – strongly sug­gests a very high de­gree of con­tin­ued in­com­pe­tence and lack of re­li­able for­ward plan­ning. For in­stance, no guid­ance that I am aware of yet ex­ists for what the Govern­ment in­tends to do about tar­iffs. In the­ory, the EU be­comes sub­ject to ex­actly the same tar­iffs as any other “third coun­try” with­out a free-trade agree­ment, such as Aus­tralia or the US, in the event of a no-deal Brexit.

But is that ac­tu­ally what the Govern­ment in­tends to do in prac­tice, given the likely im­pact on food prices and ex­ist­ing supply chains? And if it does, will it cut taxes such as VAT to com­pen­sate? It could of course de­cide not to im­pose any tar­iffs at all on the EU, but if it does, it would be forced un­der WTO rules to of­fer the same tar­iff-free trade to ev­ery­one else. Is uni­lat­eral free trade an op­tion or not? Al­ter­na­tively, it could set its own univer­sal tar­iffs ac­cord­ing to the per­ceived needs of the UK econ­omy. But should we not by now know what these are likely to be?

Guid­ance is­sued by the De­part­ment of Health last week bru­tally warned med­i­cal equip­ment sup­pli­ers that their UK cer­ti­fi­ca­tion would no longer be valid in Europe af­ter March 29 in the event of no deal and “as such these prod­ucts will not be able to be placed on the EU mar­ket”. Where then are they to be placed? Since UK reg­u­la­tors in­tend to con­tinue hon­our­ing for­eign EU cer­ti­fi­ca­tion, it is not ob­vi­ous the DOH will com­pen­sate by tak­ing the ex­ports in­stead. It is a quar­ter to mid­night, and we know none of this stuff. Very de­tailed plan­ning? I can barely see any at all.

‘The un­cer­tain­ties amount to a kind of triple witch­ing hour, all con­verg­ing on the first quar­ter of this year’

A trader on the floor of the New York Stock Ex­change. Mar­kets started the new year with a tum­ble, as dis­ap­point­ing Chi­nese eco­nomic data re­newed con­cerns about a global trade war

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