For once, it’s possible to sum up the economic prospects for both the UK and continental Europe in a single word. No, not ‘China’. No, not ‘recession’. Nor is it ‘commodities’. Instead, the word is ‘Brexit’.
On the morning of 24 June, the world woke up to some unexpected news: by a margin of 51.9% to 48.1% the UK electorate had voted to leave the European Union. The country’s new prime minister, Theresa May, has since confirmed that Article 50 of the Lisbon Treaty will be triggered by the end of March 2017 and the formal, two-year process to take the UK out of the EU will begin.
The pound promptly slumped to a 30year low against the US dollar, crashing from $1.50 to $1.30, and to €1.20 against the euro. Markets have since deteriorated further, with fears of a ‘hard Brexit’ (whereby the UK would also withdraw from the European single market) driving the pound down to $1.27 – its lowest level since 1985 – and €1.13.
All of this while the UK is still an EU member, still within the customs union: tariff walls are not in place and the UK continues to enjoy unfettered access to the single market.
So, where are currency markets heading? The truth is that no one knows. Clearly, economic pundits in both the UK and Europe were caught flat-footed by the outcome of the referendum. But investment bank UBS has forecast that by end of 2017 the pound could be at $1.20 against the dollar, and that the pound and euro could be at parity. By any account, that is a remarkable transformation in sterling’s fortunes.
In ordinary times, it would be possible to sketch out the effects of such a shift. UK exports would become more competitive; UK imports more expensive. Just as overvalued currencies have stifled economic growth in countries such as Japan, a sharp currency devaluation
bolsters growth, stimulating both exports and domestic demand, albeit over a timescale measured in years, not months.
“The UK is an economy that is heavily dependent upon imports,” says Alan Braithwaite, chairman of supply chain consultants LCP Consulting.
“So, without question, given what has happened to the value of sterling, there will be higher prices coming through as imports become more expensive. Likewise, there should be a significant boost to exports, assuming continued tariff-free access to export markets.”
But these, of course, not ordinary times. In the short term, the economic impact of Brexit will be dominated by the emergency actions taken by the Bank of England, the UK’s central bank, in August: interest rates – already at a three-century low of 0.5% – were cut even further, and the bank’s quantitative easing programme recommenced. Perversely, the International Monetary Fund expects that the bank’s stimulus will put the UK on track to be the fastest-growing G7 economy this year, with GDP increasing by 1.8%.
Ironically, the contrast with the rest of Europe could not be more stark. After a lacklustre few years in the wake of concerns about the euro and member states’ sovereign debts, economic prospects for the eurozone in 2017 remain relatively muted, with the Q3 2016 Purchasing Managers’ Index showing softening economic growth in most of Europe’s major economies.
“The slowing rate of growth across the region, in part, reflects growing caution among businesses
in terms of their spending due to worries about the economic outlook, linked in many cases to political uncertainty,” observes Chris Williamson, chief business economist at analyst IHS Markit.
“We see this trend persisting into next year, as the impact of Brexit is exacerbated by uncertainty surrounding elections in France and Germany alongside ongoing political unrest in Italy and Spain.”
As a result, he adds, GDP growth in 2017 is unlikely to match that of 2016.
“While we see the eurozone economy expanding by 1.6% in 2016, even this modest growth is looking unattainable in 2017 given the heightened political uncertainty that lies ahead. Of the four largest euro states, only France is showing signs of its upturn gaining momentum, with growth trending lower in Germany, Italy and Spain.”
Just as worryingly, says Howard Archer, chief European and UK economist at IHS Markit, there are signs of softening consumer confidence, with the European Commission’s consumer confidence index retreating from a peak of -7.0 throughout the euro area in May to a four-month low of -8.5 in August, before edging up slightly to -8.2 in September.
“The softness in July and August retail sales is particularly disappointing as the consumer seemed to have a key role to play if eurozone growth was to regain momentum after its second-quarter slowdown,” he observes.
“Consumer spending growth actually slowed appreciably in the second quarter after a strong start to the year and a decent expansion in 2015.”
If Europe’s consumers, and therefore businesses, are feeling more cautious, UK consumers and businesses have even more cause for concern once the Bank of England’s stimulus wears off, as it eventually must.
Because quite apart from the effect that Brexit will have on the pound, the bigger impact on the economy will be the shape of the Brexit that eventually emerges, and the eventual answers to issues, such as access to the single market, continued membership of the customs union, and the workability of various halfway houses, such as membership of the European Economic Area, or membership of the European Free Trade Association.
Simply put, if a hard Brexit occurs – which seems increasingly likely – with no, or limited, access to the single market, and withdrawal from the customs union, then cross-border trade will be increasingly expensive and timeconsuming. At the very minimum, the UK will have to apply World Trade Organisation rules, imposing tariffs on imports where none currently exist. Nor will the widely anticipated failure of the Transatlantic Trade and Investment Partnership (TTIP), a trade deal between the US and the EU, help matters.
As a statement from the UK’s Chartered Institute of Logistics and Transport pointedly put it: “It is important that trade and the movement of goods is not tipped back into a former era of high-friction trade with an uncertain timetable for the re-establishment of open trade terms. Such an outcome would increase the cost of trade and extend shippers’ supply chains, adding potential unreliability”.
Consider the UK’s automotive industry, for instance, which employs 140,000 people. It is the country’s third-largest industry – and the third-largest automotive producer in Europe – and produces a vehicle every 20 seconds. Almost 80% of these are exported, mostly to the EU. Sunderland’s Nissan car plant is the UK’s single largest vehicle assembly site, producing one in three UK-built cars, of which roughly 55% go to the EU.
Yet some 59% of the components used in UK vehicle production are imported, predominantly from the EU. Jaguar Land Rover, for instance, sources around 1,100 collections a week from 480 suppliers in 17 countries, with the components delivered to the company’s two UK cross-docks via a network of seven consolidation cross-docks spread across Europe.
Quite apart from headline-making pronouncements by the respective heads of Jaguar Land Rover and Nissan, which have called into question continued investment in UK operations if the country exits the single market, it seems improbable that the combined effect of tariff walls and the collapse of sterling will not see some impact on the economy in the form of changes to sourcing patterns.
“It is reasonable to expect that new long-term sourcing decisions by UK buyers will be tipped towards local UK suppliers rather than overseas or European suppliers,” says Soroosh Saghiri, senior research fellow at the Centre for Strategic Procurement and Supply Chain Management at Cranfield University School of Management.
“There are too many uncertainties about Brexit, about the continuation of the customs union, and about the value of sterling. The closer that the pound gets to parity with the dollar and the euro, the more likely that will be,” he adds.
LCP Consulting’s Braithwaite agrees, arguing that there will be an undoubted increase in both inshoring and nearshoring as nervous procurement functions seek to reduce risk, reduce trade frictions, and reduce costs.
“In many companies, the procurement function is going to have to do a full drains-up review, looking at the impact of a post-Brexit future. The big question will be whether the data is there to support the decision-making that needs to be made in terms of evaluating the total cost of procurement,” he says.
“Potentially, the UK is erecting a wall between it and its biggest trading partner, and the effects – to both the economy, and to individual businesses and procurement functions – are going to be significant.”
Read more about procurement’s plans for the new year with the rest of the Procurement in 2017 series:
This article is a piece of independent journalism, written by an experienced journalist and commissioned exclusively by Procurement Leaders.