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Brexit round-up - Issue one

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Welcome to our first round-up of Brexit news, where we update you on the most recent developments. To receive future updates direct to your email inbox, register your interest in Brexit news. 

 

  1. Sterling is weak but stable … for now 
    Is this good for the grocery sector?
  2. Consumer confidence is holding steady but businesses are nervous 
    What’s really going on and will it last?
  3. Brexit negotiations – Brexit means Brexit say ministers but progress, what progress?
    We look at what has happened so far and what the process of negotiations could look like 
  4. International reactions –The international response was cautious at first but now people are becoming more outspoken 
    Can the UK count on its traditional friends?

 

1. Sterling is weak but stable … for now. Is this good for the grocery sector?

One of the areas that companies will be watching most intently throughout the Brexit process is the movement of currency. It has a big impact for businesses, governments and consumers.

Many key economic indicators for the UK (e.g. bank lending, employment, GDP) have remained positive but one vital measure has weakened: the value of Sterling.

Sterling has been losing ground for some time versus the Euro and the Dollar, as shown on the chart. This predates even the announcement of the referendum but accelerated after the result. A Pound is currently worth about 14% less than it was a year ago.

UK currency performance vs Dollar and Euro

Source: O and A, September 2016

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What it means

Weaker currency means that imported goods, energy, services and international debt repayments cost more. Businesses experience the inflationary effect first but it is usually transmitted over time to shoppers.

For the UK, domestically produced goods have become more competitive, both at home and overseas. UK export volumes for groceries are currently expanding and the prices realised are also rising, when the proceeds are converted to Sterling.

For companies elsewhere in Europe, selling into the UK has already become more challenging.

There is little sign of any inflationary stimulus just yet. ONS data on input costs shows only a slight uptick whereas price changes for shoppers remain downwards.

Input prices for UK manufacturers

 

Source: Table T5, Producer Price Inflation MM22, ONS, September 2016
Codes refer to specific ONS measures, indices rebased by IGD

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Many businesses (and government) would welcome a return to modest inflation because this helps to promote consumer spending and encourage sales growth.

Why prices have not yet been much affected

Other forces in the global economy are helping to suppress international market prices. Uncertainty surrounding elections to come in the US, France and Germany are all contributing, as are concerns about overheating of the Chinese economy.

Another reason why input costs appear to be unresponsive is that businesses protect themselves against volatility through currency hedging, forward buying and so on. However, all these approaches have one thing in common – sooner or later, they end and market forces prevail. So the inflationary impacts of currency change for businesses can be delayed but not indefinitely.

What might happen next

Currency movements are notoriously difficult to predict and IGD is not in a position to advise in this area.

However, although Sterling has been stable in recent weeks, further fluctuations appear almost inevitable, linked in particular with news relating to trading negotiations. The fluctuations could be both upwards and downwards.

If doubts grow about the UK’s future, then the value of Sterling is likely to fall. However, this is relative to other currencies which will also be subject to risks and government actions. For instance, if extreme political parties threaten to make headway in various European national elections, this could destabilise the Euro currency.

Various governments will be hoping for a weak enough currency to promote exports but not so weak as to promote inflation and undermine consumer spending. It is a difficult tightrope to walk. We will continue to watch currency movements closely.


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2. Consumer confidence is holding steady but businesses are nervous. What’s really going on and will it last?

IGD’s research shows that UK shopper confidence, in aggregate, has not been jolted by the referendum campaign and its outcome. Business confidence, in contrast, remains in long term decline, which began before the referendum was even announced.

Shoppers feeling tentatively positive

IGD’s ShopperVista research shows a gradual improvement in consumer confidence over the last five years, with successively fewer shoppers expressing concern about their personal financial prospects.

It is true that only a minority expect to become better off in the year ahead but most people do at least expect to maintain the status quo.

Confidence did worsen a little in July and August 2016, immediately after the referendum result but this was a minor effect compared with the aftermath of the Credit Crunch.

UK shopper confidence is holding steady

Personal financial expectations, next 12m

Source: ShopperVista, IGD Research, September 2016
Base: 1,000 main shoppers per month

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Of course, the averages hide some big shifts at an individual level but for every person alarmed at the prospect of Brexit, another is delighted and anticipating better times ahead.

Another key indicator is inflationary expectations. For food and drink, this worsened slightly after the referendum but predictions for price increases remain muted, when compared with the long-term record.

Concerns over future prices are marginally elevated

Grocery price expectations, next 12m

Source: ShopperVista, IGD Research, September 2016
Base: 1,000 main shoppers per month

DOWNLOAD CHARTS AS A PDF

The acid test is spending. Grocery retail sales volumes have been rising slowly all year and since the referendum, sales value has been in slight growth too, in spite of subdued prices.

The contrast with companies

Business confidence measures are available from a range of sources. Well-known examples include the Markit CIPS UK Manufacturing PMI, the Lloyds Business In Britain report and the ICAEW UK Business Confidence Monitor.

These show that business confidence is declining slowly, predating announcement of the referendum and even the 2015 general election. It suggests that companies have some deep-seated strategic concerns, echoed in the financial markets with unprecedented low returns from government bonds.

Business confidence is in long term decline

Business confidence

However, actual behaviour is more positive. Business borrowing is increasing (source: Bank of England) and capital investment is also growing (source: ONS).

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What it means

From a shopper point of view, little has changed since the referendum. Employment remains high, wages are growing, many people are better off in real terms than last year.

These personal experiences have, apparently, outweighed concerns from experts and commentators. However, based only on recent economic performance, we might expect shopper confidence to be even higher, so the risks have permeated public consciousness to some extent.

Regarding businesses, the mismatch between the downbeat mood and rising investment is hard to explain. It may be that business is seeing the need to capitalise on new technology and taking a long term view. However, even if investment is increasing, government will be hoping for a sharper acceleration.

What might happen next

Governments in the UK and EU remain in the preparation phase. No big actions have been taken as a result of the referendum, the course ahead is unclear and so the macro-economic situation remains broadly unchanged.

As negotiations between the UK and EU advance, the rate of inflation will be a critical indicator if only because of its powerful influence on shopper confidence and behaviour.

Companies will be fixated on any news that indicates the likely trade deal between the UK and EU. If this looks set to be broadly business-friendly it will trigger a strong sense of relief. Even major new impediments to trade appear the more likely outcome, investment could be sharply reduced.


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3. Brexit negotiations – Brexit means Brexit say ministers but progress, what progress? We look at what has happened so far and what the process of negotiations could look like 

The new British Prime Minister immediately set to work by creating two new Departments, abolishing one, reorganising a few others and appointing a new Ministerial team.

David Davis heads up the new Department for Exiting the European Union which will be responsible (apart from when the PM takes personal charge) for managing the meticulous and intricate negotiations.

Liam Fox heads up the new Department for International Trade, responsible for promoting UK trade abroad and securing the UK’s trading relationships.

There are two key sets of negotiations: the withdrawal agreement (the ‘terms of the divorce’) and the future UK–EU relationship.

The withdrawal agreement will cover immediate issues such as the rights of EU citizens in the UK and of UK citizens abroad, the relocation of EU agencies currently based in the UK and the reallocation of unspent funds, such as those reserved for UK regions and farmers. These are the negotiations that are triggered by Article 50 of the Lisbon Treaty.

Negotiations on the UK’s future relationship with the EU will be more broad-ranging and time consuming. Furthermore, leaving the EU will also affect trade deals with the rest of the world and so the UK will need talks with non-EU countries and key international institutions, such as the World Trade Organization (WTO).

The Government has indicated its intention to involve the devolved administrations in the negotiations and local government will also have an interest.

What’s happening now?

It is not a criticism to say that things are moving slowly. Civil servants have only just taken up the senior posts in the new ‘Exit’ Department with more appointments to be made. Ministers and officials across Whitehall are undergoing meetings with swathes of stakeholders to ensure the UK’s negotiating position is fully informed.

Now is the time for companies to make their voice heard, if not directly then through their trade associations. IGD is not a trade association and never lobbies government but organisations such as the Food and Drink Federation, the British Retail Consortium and the National Farmers Union are fully engaged.

What will happen next?

Article 50 gives little detail about how the withdrawal negotiations will be run, stating that the European Council will agree guidelines. There have already been disagreements between the Council of the European Union (the politicians) and the European Commission (the administrators) on who should take the lead.

The Council has appointed a diplomat to lead its ‘Brexit taskforce’, which it expects to be supported by Commission officials. In practice, the negotiations may be complex, with a series of informal bilateral discussions between member states and the UK taking place alongside the formalities.

Article 50 sets a two-year deadline for a deal to be struck and it remains to be seen when this will be invoked. This period, however, only applies to the withdrawal agreement. Negotiations on the future UK-EU relationship have no time limit and are likely to be resolved in a series of stages.

There will be a default position until all details are finally resolved and potentially interim arrangements. For example on trade, the automatic default would be for WTO rules, placing the UK outside the EU’s Common External Tariff although an interim tariff-free period could be agreed.

So this is a multi-layered process that will depend on goodwill from all parties. We should anticipate many twists and turns as the full story unfolds.


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4. International reactions – The international response was cautious at first but now people are becoming more outspoken. Can the UK count on its traditional friends?

International reaction to the Brexit vote was initially cautious but more recently we have seen some stronger comments revealing a range of reactions.

Within Europe there is a clear divide. Some leaders are urging the UK to leave as soon as possible. They wish to make faster progress towards European integration and feel the removal of the UK would make this possible. They also want to set a harsh example to deter others from considering a breakaway. For instance, France has a national election in 2017 and the possibility of Frexit (or Frortie) is appealing to a growing number of nationalists.

Leaders on the other side of the debate want to minimise disruption and mitigate the risks. They would like to see a ‘soft departure’ for the UK that takes place gradually and maintains trade. Conscious of the views of their own electorates, they are less enthusiastic about further European integration. They also suspect that if negotiations are protracted enough then Brexit might not happen at all.

Beyond Europe

Further afield, the divide is about where the UK now sits in the priority list.

There have been positive noises from China, Canada and India about exploring a Free Trade Agreement with the UK. After the G20 Summit in Hangzhou, China President Xi indicated he wanted to look at how China could strengthen its trading and economic relationship with the UK and Theresa May hopes to lead are large business and academic delegation to China next year.

Australia has shown the most enthusiasm to start discussions with the UK Government on a bilateral agreement and its Trade Minister has already visited London to begin the process, while admitting that nothing can be finalised until the UK has left the EU.

The UK Department for International Trade will now organise a working group with their counterparts from Canberra and the Indian Government has indicated the same should happen with a team in New Delhi.

In contrast, the US has made it clear that it has bigger issues to consider. It is engaged in two sets of complex negotiations with Europe (TTIP) and the Pacific Rim (TPP) and so it has no appetite to open up a new front with the UK. This could change though, if other discussions grind to a halt or the new President sets a different direction.

Japan has been the most outspoken. In a 15-page Message to the United Kingdom and the European Union published on the eve of the G20 summit, a Japanese government task force formed to respond to Brexit cites numerous concerns.

For instance, will Japanese financial institutions need to apply for corporate status in the EU if they lose the automatic 'single passport', i.e. the right to operate across the bloc?

Japan, has advised the UK government to try to retain full access to the EU single market and to avoid customs controls on exports. It has raised worries over ease of access to unskilled labour, tariff protection and London's status as a clearing centre for euro transactions.

Clearly the UK faces a major diplomatic challenge, reconciling a range of views, identifying its best allies, calming concerns, prioritising but also seeking to make progress on several fronts simultaneously.

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