While the pros and cons of leaving the European Union continue to be debated, the shifting debate and deadlines are making the trajectory of the UK economy particularly tricky to forecast. The first quarter of this year saw surprising strength in the manufacturing sector, contributing to stronger than expected growth to the economy. The service sector was showing signs of slowing but manufacturing and industrial production data was positive. Unemployment is as low as it has been since 1974 and wages are growing faster than inflation. These are all reasons to expect the Bank of England are able to raise rates. Members of the Monetary Policy Committee (MPC) have recently indicated that rates may rise sooner than markets are pricing. However, the MPC bases its predictions on a smooth exit from the EU, and that is far from certain.
This month we saw industrial production fall sharply and the Manufacturing Purchasing Managers Index (PMI) was down more than anticipated. This confirms the view that the first quarter was stronger due to companies building up inventories before the end of March, fearing that the UK would leave the EU without a deal. As inventories unwind, production falls, however they may be building inventories again before the end of October. The speed and scale of inventory changes distorts short-term data, making reading the economy particularly challenging. The impact of cut backs in the car industry by Nissan, Honda and Ford have yet to be felt and will take longer to come through. Mark Carney has described the current situation as the 'fog of Brexit', that is unlikely to clear any time soon.
The ongoing Tory leadership election is an additional uncertainty. The front runner, Boris Johnson, is yet to rule out proroguing Parliament, as suggested by Dominic Raab, to get a no deal exit through. Parliament is suspended when an election is called, which means that no new legislation can be made. As it stands, with no agreement, the UK would leave on the 31st of October unless an alternative is agreed. To prorogue Parliament to get a no deal Brexit would cause a constitutional crisis, which for many parliamentarians is unthinkable. The alternative is to renegotiate the deal, which the European Commission have ruled out. When the new Prime Minister is chosen, the 'fog of Brexit' may be thicker than ever.
Measuring the economic impact of Brexit will remain difficult and continue to distort the figures in both directions as deadlines come and go. Regardless of this, the UK stock market is doing well with a high proportion of overseas earnings making it less susceptible to the UK economic swings. It is further supported by a dividend yield of close to 5%, which compares favourably to ten year gilt yields of close to 0.8%.
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