Screaming for a Deal

In its August 2 MPC meeting, the Bank of England held its policy rate fixed at 0.75 percent keeping

it stable for a year after it was hiked by 25 basis points in August 2018. Since then a lot has

changed. Hope of an EU withdrawal deal has translated into a real risk of hard Brexit; US – China

trade wars have turned uglier; global growth has softened; central banks have either delivered rate

cuts or have hinted at one notwithstanding the already negative deposit rate. Subsequently, the

yield curve from the forwards and OIS had priced in a 25 bps rate cut.

BoE, in its August 2019 inflation report attributed low yields to high demand of safer assets in a

slowing global economy alongside Brexit. The rate cut was not delivered. The bank perhaps wants

to keep more ammunition for a no-deal EU withdrawal, which is not factored explicitly into its

economic forecast models.

GDP growth in Q2, 2019 is expected to be flat after growing 0.5% in Q1. The 2019 GDP forecast

for growth is revised downwards to 1.3% from previously 1.5%. The 2020 forecast is also revised

down from 1.6% to 1.3%.

With the Prime Minister Johnson disagreeing to any sort of Irish backstop and the EU insisting on

it, a smooth Brexit assumption appears weak. Any forecasts on such assumptions could therefore

be far from the truth. The bank has noted that the probability of a hard Brexit, as implied through

bets, has reached around 40%. A significant figure for this kind of event.

Office for Budget Responsibility (OBR), in its July 2019 Fiscal Risk Report uses hard Brexit only as

a stress-test scenario, sending the UK into recession with even 2020 real GDP estimates down by

2%. While the August MPC minutes and inflation report remains silent on no-deal, no-transition

Brexit, the BoE Chairman Mark Carney, in an interview to the BBC has alluded to very big and

highly profitable industries suddenly becoming uneconomical if such a scenario was allowed to

happen.

In the meanwhile, retail segment has also demonstrated stress with BRC-KPMG July report

pointing to 3 month average sales falling to 0.1% and the 12 month sales declining to as low as

0.5%. Though the July numbers were expected to be low due to a higher base effect, the moving

averages weakness is a reason to worry.

Most quarterly trading updates from the UK retailers are mentioning the subdued demand. While

many UK retailers are trying to find a silver lining in their trading statements, Sainsbury plc, the

second largest UK retailer, is more upfront in clearly communicating that its total sales declined by

1.2 percent as grocery sales contracted by 0.5% and general merchandise and clothing by 3.1 and

4.5% respectively.

The glut in retail spending comes alongside falling permanent and temporary staffing as it fell for

the sixth time in past seven months in July. The UK Jobs report, by Markit/REC released on August

8th, notes that the availability of workers continued to remain low, pushing the starting salary higher

although at a softer pace. This is expected to further increase the cost pressure in wake of low

demand.

While the global markets are all sluggish, the idiosyncrasies for the UK stem from the unknowns

around Brexit and not as much from the Brexit itself. There is an urgent need to know whether or

not will there be a transition period in the exit process. As soon as the much needed transition

period starts to appear, the consumer confidence can be expected to bounce back providing

investment opportunity for healthy businesses.

Aseem R

REFERENCE

1. BoE MPC minutes July meeting
2. BoE August inflation report
3. OBR – Fiscal Risk Report July 2019
4. BRC-KPMG July retail report
5. Markit / REC UK Jobs report
6. Tesco, Sainsbury trading statements