UK: Business confidence hit hard after Brexit vote - MUFG

Lee Hardman, Currency Analyst at MUFG, suggests that the foreign exchange market has been relatively stable in the Asian trading session with the pound remaining on a weaker footing following the release on Friday of the weaker than expected UK PMI surveys for July.

Key Quotes

“The surveys revealed that business confidence declined sharply following the Brexit vote increasing the likelihood that the UK economy could fall into recession in the coming quarters. The composite PMI survey declined by a larger than expected 4.7 point to 47.7 in July reaching its lowest level since April 2009. Markit stated that the dramatic deterioration in business confidence was consistent with the UK economy contracting by a quarterly rate of 0.4%. The sharp drop in business confidence was evident across all sectors of the economy with both the services and manufacturing PMI surveys declining sharply to 47.4 and 49.1 respectively. However, Markit did note that the sharp Brexit-driven plunge in the pound is helping manufacturing exports to expand at their fastest pace in almost two years.     

There is some hope that the initial hit to business confidence evident in the PMI surveys could exaggerate the scale of the economic slowdown underway in the UK. The release this week of the UK GDP report for Q2 is expected to reveal further evidence that the economy was more resilient than expected heading into the referendum. Other survey evidence since the referendum has also sent more mixed signals over the likely performance of the UK economy.

Furthermore, as Markit noted they have already seen some improvement in business confidence after the quick appointment of Theresa May as Prime Minister. Once businesses’ become more familiar with Brexit uncertainty which is likely to persist for a number of years, it appears reasonable to expect business confidence to gradually rebound after the initial sharp plunge although remain consistent with weaker economic growth.                     

The PMI surveys will strengthen the case of the more dovish MPC members such as Haldane and Vlieghe who have called for a more aggressive and timely package of easing measures to be announced at the BoE’s next policy meeting on the 4th August. In contrast, MPC members Forbes and Weale have more recently made the case that the BoE should take its time to more fully assess the fallout from the Brexit vote for the UK economy before deciding on the optimal setting for monetary policy.

New Chancellor Philip Hammond stated at this weekend’s G20 meeting that “in the short-term, our colleagues at the Bank of England will be using the monetary tools at their disposal”. In addition he added that “over the medium-term, we will have the opportunity with our Autumn Statement, our regular late year fiscal event, to reset fiscal policy if we deem it necessary to do so”. The comments provide a further strong signal that the government is prepared to loosen fiscal policy to support growth although with the budget deficit still elevated the scope for stimulus is modest. He also attempted to provide some reassurance by stating that the government’s job was to “restore certainty, as much as we can, as quickly as we can”. 

The impact of the Brexit vote reportedly dominated the first day of the G20 meeting of finance ministers and central bankers. The final communique acknowledged that the Brexit vote “adds to uncertainty in the global economy” whose recovery is “weaker than desirable “. G20 members hoped to see the UK as a close partner of the EU in the future. It has been reassuring so far that negative spill-over effects from the Brexit vote to other economies have been limited.

In these circumstances, we continue to expect that the pound will underperform in the near-term and the euro to a lesser extent.”