Brexit Shadow Hides Deeper Cracks in U.K. Economic Firmament

  • Gross domestic product grew 0.4% in first quarter, ONS says
  • Data shows services slowing, industrial production declined

Brexit - the End of Europe as we Know it?

Britain’s vote on its future in the European Union is diverting attention from deeper economic problems.

As the country thrashes about in an identity crisis, risking a schism with its main trading partner, growth is losing momentum and continues to be lop-sided. Services, the engine of the economy’s recovery, expanded at the weakest pace in almost a year in the first quarter, while industrial production extended its decline.

That underscores the fragility of the economy at a time when the Bank of England is warning uncertainty stemming from the June 23 referendum may already be having an effect. Added to that, some of the nation’s biggest companies are in crisis, with two retailing stalwarts appointing administrators in the past week and Tata Steel’s move to sell its U.K. business raising questions about the future of British industry.

“The U.K. economy would have probably been moderating regardless of any Brexit uncertainty,” said Simon Wells, an economist at HSBC Holdings Plc in London. “If, or when, the near-term uncertainty lifts we’ll be right back to the same old puzzles.”

Turbulent Opening

While the first-quarter data reflect a turbulence that roiled global markets at the start of the year -- and which has since abated -- four years of solid consumer spending hasn’t been enough to protect even some firms that feed on domestic demand. Department-store operator BHS Group Ltd. and formalwear retailer Austin Reed succumbed to years of intense competition in the past week, while high-street fashion chain Next has warned the outlook is worsening.

Britain’s reliance on one part of the economy is likely to fuel concern that the pace of growth isn’t sustainable. The slowdown in services was driven by business and finance, which grew 0.3 percent in the first quarter -- less than half of the pace of the previous three months. Industrial production shrank for a second straight quarter and construction slumped.

There may also be a risk of consumer fatigue. With the savings rate at a record low, households may at some point start to think about their own reserves and curtail spending. The Confederation of British Industry’s retail sales fell to its lowest level in more than four years this month.

“It appears that the economy has hit a speed bump.” said Azad Zangana, an economist at Schroders in London. “Growth is likely to remain sluggish until the result of the referendum is known. If the U.K. votes to remain in the EU then growth is likely to accelerate significantly in the second half of the year. If, however, the U.K. votes to leave, then growth is likely to slow further on the back of the added uncertainty.”

‘Scaremongering’

With less than two months to go before the referendum, officials on both sides of the debate have been using the economic outlook to support their cause. Chancellor of the Exchequer George Osborne said on Wednesday that the GDP figures showed how the threat of an exit is taking its toll, while those who support leaving blamed an international slowdown and accused the ‘remain’ camp of scaremongering.

“I’m concerned about Brexit,” Standard Chartered Chief Executive Officer Bill Winters said in a Bloomberg Television interview on Wednesday, adding it could be “destabilizing” for the economy. “It’s one of those unfathomables. Its a confidence thing.”

The FTSE 100 Index has risen 1.2 percent this year, posting the best performance among major western European indexes, thanks to a rebound in miners and a weaker pound. But trading of shares on the gauge has been falling, reflecting a lack of confidence in the recent rally, and options traders have stepped up hedging as the EU vote approaches.

OECD Warning

The Organization for Economic Cooperation and Development on Wednesday joined a chorus from the International Monetary Fund to the World Bank warning about the possible implications of an exit. It said Britain would be hit by tighter financial conditions, weaker confidence, higher trade barriers and restrictions on labor mobility. The result would be an economy 5 percent smaller by 2030 compared with continued EU membership.

Earlier this month BOE officials said Brexit jitters may be weighing on investment and hiring -- unemployment rose between December and February -- and signaled they’ll take a cautious approach until the vote has passed. Governor Mark Carney has been dragged in to the highly charged debate, last week warning that London’s status as a global financial center could be diminished in the event of an exit.

The clouded outlook and the signals sent by the central bank mean economists see little prospect of any change in monetary policy, and have pushed back their predictions on the timing of a rate increase to next year. The referendum is creating a challenging backdrop for policy makers, who voted unanimously to keep their benchmark rate at a record-low 0.5 percent this month. They’ll publish new economic forecasts in May and have said that they won’t rush to over interpret data that may be skewed around the vote.

“The downward trend in GDP growth since 2014 suggests that the EU referendum cannot be blamed for all of the economy’s ills,” said Samuel Tombs, an economist at Pantheon Macroeconomics. “The fiscal squeeze has tightened this year after a pre-election pause, while the boost to growth in household spending from falling savings and rapid employment growth has run its course.”

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