Brexit Wreaks Havoc on U.K. Economy as Recession Risk Increases

Schulz: Brexit a Risk for U.K., European, Global Economy
  • Markit’s composite U.K. PMI dropped to seven-year low in July
  • Economists say survey makes BOE action in August more likely

The U.K.’s decision to leave the European Union inflicted an immediate blow on the economy as business activity shrank at its fastest pace since the last recession seven years ago.

In the weeks following Brexit, there was a “dramatic deterioration,” Markit Economics said in a one-time report published Friday. Services and manufacturing shrank and a gauge of the private-sector economy plunged to 47.7, well below the 50 level that divides expansion from contraction.

The slump is the strongest evidence yet that politics is propelling the world’s fifth largest economy into recession. It intensifies pressure on the Bank of England to deliver fresh monetary stimulus and on the government to reverse fiscal austerity. The pound dropped after the report was published, with Markit saying its latest readings put the economy on course to contract by 0.4 percent this quarter.

“July’s PMI certainly points to more easing,” said Samuel Tombs, an economist at Pantheon Macroeconomics in London. “We’ve seen a variety of business measures fall to levels not seen since the financial crisis. Although consumer confidence might hold up for the next few months, businesses are putting the brakes on investment.”

A gauge of services, the biggest part of the economy, dropped to 47.4. The slide in the composite Purchasing Managers’ Index was sharper than economists had predicted and was the biggest drop on record. It’s now at the lowest since April 2009, when the global financial crisis had helped push the U.K. into five straight quarters of contraction, and then Prime Minister Gordon Brown said an “international hurricane” was battering the world economy.

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“The downturn, whether manifesting itself in order-book cancellations, a lack of new orders or the postponement or halting of projects, was most commonly attributed in one way or another to Brexit,” said Chris Williamson, chief economist at Markit.

The pound dropped 0.9 percent to $1.3107 at 2:07 p.m. London time. Markit collected the data between July 12 and July 21. It released the survey -- based on about 70 percent of usual replies -- to provide clarity on the impact of the referendum.

G-20 Response

The report also raises questions on the impact on the international economy. The IMF downgraded its global growth forecast this week, and Group of 20 nations officials, who are meeting in China this weekend, are planning to say they’re capable of dealing with the economic fallout of Brexit.

For BOE Governor Mark Carney and fellow officials debating whether the U.K. economy needs more stimulus, a key question will be whether the signs of weakness persist or just reflect an initial post-referendum shock. Williamson said the slump in the PMI “will provide a powerful argument for swift action.”

Twitter: Markit Economics on Twitter

While most Monetary Policy Committee members say that action is required at the next meeting, two of its nine officials -- Martin Weale and Kristin Forbes -- have argued that they need further evidence of the impact Brexit is having. Investors are now pricing in an 88 percent chance the BOE will lower its key interest rate from 0.5 percent at its announcement on Aug. 4.

Even with a weakening economy, the U.K.’s political circumstances don’t favor a reversal of the vote. New Prime Minister Theresa May has ruled out repeating the referendum, and has adopted a new catchphrase: “Brexit means Brexit.”

As she enjoys her honeymoon as a new leader, lawmakers in her Conservative Party are already warning her that they would be infuriated by any attempt to back away from that pledge. Rows over Europe have helped to bring down every Tory prime minister since Margaret Thatcher.

Corbyn Future

Nor is she going to face much pressure from the opposition Labour Party. It’s deeply split, with lawmakers mainly against leaving the EU, while leader Jeremy Corbyn has called for talks on departure to start immediately. To complicate matters further, many of the party’s heartlands voted to leave.

That could change if the man who’s challenged Corbyn for the leadership, Owen Smith, were to win the coming contest. Smith has called for Britons to get the chance to vote again once the shape of the Brexit deal is clear. But with the party membership apparently firmly behind Corbyn, Smith’s chances of being in a position to push for such a vote look slim.

Markit’s report contained one bright spot as an index of new manufacturing exports rose to the greatest extent for almost two years, thanks to the sharp fall in the pound since the June 23 vote. But the exchange rate also led to a “steep rise” in input prices, and factories reported further job cuts.

Coordinated Policy

“The PMI data is a measure of sentiment, it’s not a measure of any hard activity in the economy,” Chancellor of the Exchequer Philip Hammond told Sky News in Beijing on Friday. “What it tells us is that people’s confidence, businesses’ confidence has been dented. They’re not sure, they’re in a period of uncertainty now. And our job is to try to restore certainty.”

Earlier Hammond, who is attending the G20 meeting, said he’s ready to “reset” Britain’s fiscal policy if needed. He also signaled budget and monetary policies will be closely coordinated to stem any Brexit-related turmoil, with the BOE taking the lead. “In the short term, our colleagues at the Bank of England will be using the monetary tools at their disposal,” he said.

“The latest PMIs add to the growing body of evidence that firms have become significantly less confident about the outlook for investment and hiring,” said James Smith, an economist at ING Bank NV in London. “This helps cement our view that the Bank of England will deliver additional stimulus.”

Bloomberg.com: Brexit Fallout indicators

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