Brexit fears wane, but UK economic momentum has suffered

27 May 2016

It feels to me that we may have seen a turning point in the EU-referendum campaign 2 weeks ago, when the Bank of England publicly pointed out negative economic consequences of a Brexit and the Leave campaign's figure head Boris Johnson likened EU politics with the imperialistic wars of Adolf Hitler and Napoleon Bonaparte. Since then the broader public seems to have grasped that there is an economic dimension to the EU Referendum and that the arguments of Remain campaign probably have more credibility in terms of support from independent, recognised economic institutions.  Currency markets and the odds at UK bookmakers reflect this as the 3 charts above demonstrate.

The media suddenly appears to focus more on those opinion polls that show a more distinct '˜Remain' majority, even though the polls themselves don't appear to have seen as marked a change as what we would refer to as the '˜money committed polls' represented by the first 2 charts. Just under 4 weeks until from the referendum, there is therefore a discernible momentum towards a Remain majority. This should be a relief to the UK's economy which currently feels like it is holding its breath. Unfortunately, such economic suspense has a negative impact on the economy and so while the Q1 GDP growth rate was just confirmed at an annual rate of 1.6%, this is highly likely to have dropped to 0% or worse for the current quarter. Once the collateral damage of the referendum on the economy finds its reflection in the economic data, David Cameron will have to explain, why he thought the appeasement of a fraction of the Tory party was worth a reduction in the nation's 2016 income. Especially, when he knew all along that the economic consequences of an actual Brexit would be as substantial as he and his chancellor are portraying them to be at the moment. This smacks of a degree of recklessness which will not help to win back those who have lost their faith in mainstream politicians and have drifted to the extreme right and left of the spectrum. While I normally refrain from discussing politics here, the recent rise in popularity of political extremes poses a risk to the economy that is not to be underestimated. We have therefore dedicated an article of this week's edition to the this cross-relationship.

Beyond UK politics, one of the other political risks of 2016 to the economy was mitigated during the week -EU and IMF agreed steps to defuse a renewed Greek debt crisis. However, for what seems like the umpteenth time, the proverbial '˜can' was yet again kicked down the road yet again. For 2016 there should not be any further risk emanating from the Greek public debt mountain for the European economy. However, come 2018 at the latest, expect an episode #4 in the Greek Debt Crisis series. Looking beyond Europe we observed mixed economic data releases, where business activity reports are currently no longer showing improvements (stalling PMIs), but the economic parameters that worried markets so much at the beginning of the year, experienced further relief. Namely an uptick in inflation in the US, the price of oil rising through $50/bbl for the first time in a year and a marked improvement in economic sentiment both in the Eurozone and the US. In summary then, the longer term outlook continues to improve while economic growth progress may have paused, following the sharp uptick after the winter blip. This creates a somewhat uncomfortable environment for markets, because without unambiguous evidence of sustained economic growth, they remain vulnerable to political risks stemming from both the UK' EU referendum and the US presidential election.

Furthermore, the recent return of the US$ strength and the oil supply overhang not having disappeared also have potential to challenge the recently more upbeat outlook. We will therefore remain vigilant in our monitoring of the various parameters of the Global economy and weigh the merits of long term growth against the unpleasantness of short term volatility in our portfolio positioning. We expect this to gradually shift from its more defensive position of the past 8 months towards a more optimistic orientation in the near future.