Whither the British economy? And Sterling...

• 10-May-21
• admin

Economic data released last week showed that the UK lost momentum in its GDP growth during 2020. This is obviously the result of the disruptive lockdowns that the UK government had to impose during much of last year. That is not surprising because most of the world has been similarly afflicted. But it is the magnitude of the decline for the UK that is astounding. A Financial Times report on Feb 13 revealed that the UK economy recorded its worst economic performance for more than 300 years. 300 years!

UK suffers biggest drop in economic output in 300 years Valentina Romei and Chris Giles in London

"Official figures on Friday showed that the UK produced 9.9 per cent fewer goods and services last year than in 2019, a contraction worse than the 1921 slump after the first world war and Spanish flu — and almost as bad as the contraction in great frost in 1709 when the UK was an agricultural economy. But as companies and households learnt to live with Covid-19 lockdowns, economic performance improved during the year and Britain’s economy grew 1 per cent in the final quarter, the Office for National Statistics said."

 

Financial Times, 13 Feb

 

1709 was 312 years ago.

 

Is that bad? It's hard to say. If you believe what a British government official said, that the economy is now like "a coiled spring", ready to bring the whole economy back to life in 2021, then the worst economic performance in some 300 years during 2020 will soon become history. On the other hand, if the bleak performance continues, we may read some headline in the future that says "worst economic performance in 301 years..."

 

We are not here to predict the UK's economic performance in the future. We would however like to examine some of the roadblocks that may get in the way of a speedy recovery. There are problems that the UK will need to address if that economic performance of 2020 is not going to be repeated. And it will not have anything to do with Covid 19. That will pass, once there are enough vaccinations. More to the point is how is the UK going to handle its new status as an EU-independent economy. That will have more far-reaching and longer consequences than the pandemic imposed.

 

The whole idea of Brexit is so that the English Channel becomes a hard border between the British and European economies. The British government was more ebullient about the “successful conclusion” of Brexit talks last December than the Europeans were. Brexit did end in consensus, but it is not clear that this consensus was something the Europeans were actually enthusiastic about, despite the one-sided declarations of win-win by Boris Johnson, who obviously spoke from his position as a Brexit promoter.

 

Now that the talking is over, the actual trade under new complex rules has to begin. It has apparently not been an easy start. The New York Times carried an article at the end of last week:

53 Tons of Rotting Pork and Other Brexit Nightmares

By Peter S. Goodman, Stephen Castle and Eshe Nelson

 

Feb. 12, 2021

 

LONDON — As the new year made Brexit a reality, Tony Hale encountered the pitfalls of Europe’s redrawn geography. Specifically, he confronted the need to extricate 53 tons of rotting pork products from administrative purgatory at a port in the Netherlands.

 

For more than two decades, Mr. Hale’s company had shipped pork to the European Union without customs checks, as if the United Kingdom and the continent across the water were one vast country. With Britain now legally outside the bloc, exporters suddenly had to navigate inspections, safety regulations and a bewildering crush of paperwork.

 

For Mr. Hale, incorrectly prepared documents meant sending five containers full of pork to an unplanned final destination — the incinerator.

 

“It’s a new game, and we have got to learn the rules,” Mr. Hale said. “We are having to double- and triple-check every document.”

 

In the early days of the post-Brexit era, Britain is struggling to adapt to its new position in the global economy — its fortunes still tethered to the European Union; its companies on the outside. The trade deal Britain struck late last year with the European Union stopped tariffs from being imposed on goods exchanged across the English Channel, but did not prevent the revival of customs procedures, health and safety checks, value-added taxes on imports, and other time-consuming, commerce-limiting hindrances.

 

Businesses across Britain are now contending with paralyzing confusion and unfamiliar bureaucratic hurdles. Paperwork snafus, customs horrors and other expensive disruptions are intensifying the strains on an economy that was already reeling from the pandemic.

 

On Friday, the Office of National Statistics announced that Britain’s economy contracted by nearly 10 percent last year, the worst plunge in centuries. Economists have anticipated a robust expansion later this year, as Britain’s vaccination campaign — among the world leaders — yields a return to normalcy, but Brexit-related mishaps are likely to limit the upside.

 

Prime Minister Boris Johnson, a Brexit champion, has portrayed Britain’s independence from Europe as a strength in allowing the government to move quickly on its vaccination drive. Administration officials have minimized Brexit troubles, describing them as “teething problems” that will subside once businesses master the intricacies of the new procedures.

 

But many companies — especially small- and medium-sized firms — lament what feels like a new normal.

The European Union has traditionally purchased nearly half of Britain’s exports. The volume of exports crossing the channel in January collapsed by more than two-thirds compared with the previous year. Some producers of fish, shellfish, meat and dairy have been cut off from markets in Europe, suffering a catastrophic plunge in sales.

 

Transport firms are so wary of the complexities of sending goods from Britain to Europe that many are avoiding the business. Roughly half of all trucks bringing goods from the French port of Calais to the English port of Dover are now returning empty, transporting nothing but thin air.

 

Britain’s lucrative finance industry has seen trading in the stocks of European companies shift abruptly to the continent, as Amsterdam has displaced London as the primary market for such shares. Growing volumes of the exotic instruments known as derivatives — especially those denominated in euros — are abandoning London for New York.

 

Manufacturers are contending with grave disruptions to their supplies of finished products, components and basic materials.

 

And the changes imposed by Brexit are only beginning, as London and Brussels continue to renegotiate the rules governing future commercial dealings across the channel.

 

“We are going to be living with Brexit for the rest of our lives,” said Jeremy Thomson-Cook, London-based chief economist at Equals Money, an international money manager. “The coronavirus is an acute condition. Brexit is chronic.”

 

Crossing the Channel

 

During the 2016 Brexit referendum campaign, those in favor of leaving Europe promised businesses liberation from the suffocating regulations and time-sucking bureaucracy that supposedly prevailed across the Channel

 

James Wilson was dubious. He harvests mussels from the seabed of the Menai Strait in northern Wales. Traditionally, such mollusks are unloved by Britons, making him dependent on Europe for 98 percent of his sales.

 

Mr. Wilson anticipated extra paperwork. He was unprepared for the shock he received last month while on a video call with the Shellfish Association of Great Britain: Under European rules, imports of live mussels were permitted from outside the bloc only if harvested in waters deemed of highest quality. The Menai Strait fell short — and not because of European perfidy, but under Britain’s own classification system.

 

He was locked out of his sole market.

 

“It was like somebody had kneed you, unexpectedly, in the groin,” Mr. Wilson said.

 

A couple of hundred tons of mussels that would have previously fetched about 160,000 euros ($194,000) now lie in the muck, not worth harvesting. Mr. Wilson has furloughed three of his six workers.

 

Even those who can reach European markets have discovered that the promised bonfire of regulations is actually a burning hell of paperwork.

 

In the southwest of England, a few miles from the village that gave its name to Cheddar cheese, one cheesemaker, Lye Cross, anticipates spending an extra £125,000 ($173,000) a year to comply with the administrative requirements that have accompanied Brexit. A transaction that last year entailed seven steps, including paying and invoicing, now runs to 39, said Ben Hutchins, the company’s sales and marketing director.

 

During the first week of January, Hartington Creamery sent about 40 small packages of its Stilton cheese to Europe. Collectively, they were worth about £1,000 ($1,383) The courier affixed a post- Brexit surcharge of around £5 each, or about £200. Customs authorities in Europe rejected the shipments, primarily because they lacked required health certificates. Preparing such documents entailed hiring a veterinarian for about £180 per shipment.

 

Hartington refunded its customers, and paid the courier again to return the cheese to England."

 

Coming back to Mr Johnson's brushing off the problems as teething ones, the question is whether these problems will cause the UK to suffer for another couple of years of no growth or negative growth. Is it really just Covid 19 or are there deeper problems revealed by the latest economic data? More specifically, is Brexit the real issue here? Brexit has already caused the UK five years of pain and if this continues, the question really is whether it is political stubbornness about a senseless economic arrangement or is it just the blind groping in the dark that will lead the UK out of the muck?

 

These trade problems are not the end of it. In the financial sector, where the City shines like a gem, there are no reasons for celebrating Brexit either. Here is an article about the situation published on 11 Feb in the FT:

 

Amsterdam ousts London as Europe’s top share trading hub Philip Stafford in London

Amsterdam surpassed London as Europe’s largest share trading centre last month as the Netherlands scooped up business lost by the UK since Brexit.

 

An average €9.2bn shares a day were traded on Euronext Amsterdam and the Dutch arms of CBOE Europe and Turquoise in January, a more than fourfold increase from December. The surge came as volumes in London fell sharply to €8.6bn, dislodging the UK from its historic position as the main hub for the European market, according to data from CBOE Europe.

 

The shift was prompted by a ban on EU-based financial institutions trading in London because Brussels has not recognised UK exchanges and trading venues as having the same supervisory status as its own.

 

Without this so-called equivalence to ease cross-border dealing, there was an immediate shift of €6.5bn of deals to the EU when the Brexit transition period concluded at the end of last year. It was about half of the amount of business that London banks and brokers would normally handle.

 

Analysts and executives say the transfer would not mean thousands of jobs leaving London, while the tax hit would be limited to the effects the move in trading would have on the profits of companies involved, they said. Financial services contributed almost £76bn in tax receipts to the UK Treasury last year.

 

“It’s symbolic in that London has lost its status as the home of EU share trading, but it has a chance to carve out its own niche on trading,” said Anish Puaar, a market structure analyst at Rosenblatt Securities in London.

 

“Fund managers will be more concerned with availability of liquidity and the costs of placing a trade, rather than whether an order is executed in London or Amsterdam,” Puaar added.

 

Paris and Dublin also had small increases in business last month as trading funnelled through the EU arms of Aquis and Liquidnet respectively, rather than through London.

 

In response, London has lifted a prohibition on trading of Swiss stocks, such as Nestlé and Roche, which is currently banned on EU exchanges.

 

Still, the large move in share trading to Amsterdam makes the city one of the early winners from Brexit. Since the start of the year, Amsterdam has also picked up activity in swaps and sovereign debt markets that would typically have taken place in London before Brexit. CBOE Europe is setting up a derivatives trading business in the Dutch capital in the first half of the year.

 

US-based Intercontinental Exchange is also planning to move the €1bn-a-day carbon emissions trading market to the Netherlands, although clearing will remain in London.

 

EU share trading could return to London as part of discussions between the UK and the bloc on financial services, analysts said. The two sides are keen to finalise a memorandum of understanding in March, although hopes in the City have faded that it will include any provisions on equivalence.

 

Andrew Bailey, governor of the Bank of England, repeated his view on Wednesday that the EU was making a “mistake” in not granting UK financial services equivalence status in most areas and, in his view, seeking to cut the UK out of European financial business “leading to the fragmentation of markets".

 

He has regularly called for the bloc to recognise the similarity of the UK's financial regulations to the EU's and grant equivalence widely, as it has already in a few areas such as central clearing and settlement on a temporary basis.

 

The governor complained that the problem with the EU's demands was that it wanted to know how the UK intended to change its regulations in the future as part of the process of granting equivalence status, which London has been resisting.

 

“This is a standard that the EU holds no other country to and would, I suspect, not agree to be held to itself. It is hard to see beyond one of two ways of interpreting this statement, neither of which stands up to much scrutiny,” Bailey said. Mujtaba Rahman, managing director for Europe at the Eurasia political risk consultancy, said the discussions would focus on the circumstances in which regulators would interact with each other. “The government isn’t really interested in equivalence because it believes the financial services sector will be better and more effectively regulated by the Treasury and Bank of England than Brussels,” he said.

 

Additional reporting by Chris Giles

If you have read these two articles about the UK economy, you would hardly be surprised that GDP growth has been the worst in three centuries. Or confident that there is a “coiled spring” anywhere on the horizon.

 

Yet the British Pound is gaining ground in the currency markets.

 

 

 

 

 

 

Here is a chart of Sterling against the Dollar and the Euro in the last 3 months:

 

 

 

Here is the chart of the Pound against the Euro

 

 

 

These charts of the Pound vs both the USD and the Euro demonstrate far more optimism about the future of the currency, indirectly about the economy, than the news is telling us directly about the economy. This does not mean that one of the two portrayals of what is going on in the UK is wrong. A country’s currency can go in an opposite direction to its economic performance for prolonged periods of time, without any apparent reason. It could be both are right.

Or it could be that one is off course. It is just that we don’t know which one.

 

However, if I am forced to bet, then I would speculate that the Sterling direction is likely to be short term. And wrong.

 

Wai Cheong

Investment Committee

 

The writer has been in financial services for more than forty years. He graduated with First Class Honours in Economics and Statistics, winning a prize in 1976 for being top student for the whole university in his year. He also holds an MBA with Honors from the University of Chicago. He is a Chartered Financial Analyst.