The British Economy Had a ‘Last Hurrah’ Before the Brexit Vote

Theresa May Chairs Her First Cabinet Meeting As UK Prime Minister
LONDON, ENGLAND - JULY 19: British Prime Minister Theresa May (C) holds her first Cabinet Meeting at Downing Street on July 19, 2016 in London, England. The new British Prime Minister was expected to set out her main priorities during the meeting, including the handling of leaving the EU, ahead of her visits to Germany and France later in the week. (Photo by Dan Kitwood-WPA Pool/Getty Images)
Dan Kitwood—WPA Pool/Getty Images

Whatever the chaos it’s heading into now, the U.K. economy had a “last hurrah” in the second quarter, growing 0.6% in the three months to June—well above economists’ forecasts, and up from 0.4% in the previous quarter.

The figure, which is likely to be revised as more hard data come in, showed that industrial output put in its strongest quarterly performance since 1999, a 2.1% rise driven mainly by the pharmaceutical industry.

But before Brexiteers get carried away on a wave of enthusiasm, it’s worth pointing out that manufacturing is only 15% of the economy. Services, which account for over three-quarters of gross domestic product, did indeed grow at a slower rate, expanding only 0.5% following 0.6% in the three months to March.

The official data follow hard on the heels of last week’s labor report, which showed joblessness at an eight-year low and the highest-ever employment rate in the U.K. in 45 years of measuring the labor force. Those figures appear to clash with the narrative that the vote to leave the European Union on June 23rd came from a population despairing at being “left behind” by the forces of globalization. The U.K. has actually grown more than any of the other three European G7 members since the financial crisis struck in 2008.

Which way now for U.K. GDP?

Philip Hammond, the new chancellor of the exchequer (the equivalent position to treasury secretary), said the figures were proof that “we enter our negotiations from a position of economic strength.”

But both employment and GDP data are essentially historical, and there is plenty of reason to think that the nicely upward-sloping line in the chart above is about to take a sharp turn downwards in the near future. A monthly survey of the distributor sector by the Confederation of British Industry, which was also released Wednesday, showed that sales volumes fell faster in July than at any time since January 2012, while a sharp drop in orders pointed to further declines in August.

Other more forward-looking or coincident indicators are also heading south. Markit’s services Purchasing Managers’ Index fell to 47.4 from 52.3 in June, suggesting that output is contracting faster than at any time since 2009. Markit’s construction PMI went the same way, falling from 51.2 in June to 46.0 this month, as uncertainty about the outlook cast a chill over big-ticket investments. Lending to businesses fell for the first time this year in June, according to the British Bankers’ Association, while mortgage approvals fell to a 15-month low.

And yet at a company level, the noises coming out of U.K. Plc during the current earnings season have been far from unanimously negative. GlaxoSmithKline (ASK) said Wednesday it will invest an extra 275 million pounds ($360 million) in the U.K. to increase production at three different sites. Homebuilder Taylor Wimpey Plc (TWODY) said that business conditions since the referendum had been “in line with normal seasonal patterns.”

“Whilst we saw a small increase in the average cancellation rate immediately following the referendum, this remained low compared to long term historic norms and is now back in line with recent low levels,” the company said in its report.

The FTSE-250, a broader and more domestically-focused index than the benchmark FTSE-100, has now made good all its losses since the Brexit vote.

Two factors go a long way to explaining the stock market’s optimism: first, both the Bank of England and the Treasury have signaled that they will loosen policy to help absorb the shock to confidence from the Brexit vote (the BoE move is likely in August after leading hawk Martin Weale changed his call in a speech last week), while the drop in sterling has prompted speculation that U.K. companies will be taken over by bargain-hunting foreigners (such as Softbank’s $32 billion deal for chipmaker ARM Holdings Plc).

But another factor may also be at work. After a chaotic immediate aftermath to the Brexit vote, Britain’s politicians have raised their game, subsequently raising hopes that the separation process will be managed responsibly and in such a way as to minimize disruption to business. New Prime Minister Theresa May’s first round of meetings with her European peers has produced some positive noises, including guarantees that thorny issues such as border controls with Ireland and France will be managed constructively and sensitively. Germany’s Angela Merkel was also conciliatory, refusing to join calls for the U.K. to get a move on with triggering formal separation talks.

In other words, the U.K. has so far avoided living up to the apocalyptic rhetoric that flooded the airwaves since June 23. It’s early days, but it is still possible to view the glass as half full, at least if you look at it from a sharp enough angle.

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