Much has happened since the UK voted on the referendum to leave the European Union (EU). Politicians have come, gone, not gone and now there is a new prime minister, Theresa May. Markets have whipsawed. All of this has led to a whiff of panic. It is time for a bit of calm and for politicians to chart a safe course for the country.
Some have made dire predictions about the country’s borrowing costs. Standard & Poor’s (S&P), a rating agency, has downgraded the UK’s credit rating. They forget that Moody’s (another rating agency) already downgraded the UK three years ago. The U.S. – the world’s largest economy – was downgraded by S&P to AA+* in 2011. The downgrades make very little difference to the economy.
Others point to Brexit (British voters’ referendum to leave the European Union) as the cause for big banks to shift jobs from the City of London. The reality is that banks are simply trying to manage costs and have been for years. Low interest rates have hit their profitability, and new regulations are costing them a lot of money. One of the largest banks has seen costs reach over $2.7 billion per year.
Any prudent bank chief executive would be looking at costs regardless of Brexit. But that doesn’t mean Armageddon for the UK’s financial services industry. HSBC** announced it was relocating its UK retail operations and 1,000 jobs to Birmingham to save costs. That’s good for the country as a whole. But both Barclays** and HSBC have recently reasserted London’s pre-eminence as the center of the financial world.
The level of the FTSE 100 and FTSE 250 have been widely, and often erroneously, cited as solid evidence of how the economy is faring. The FTSE 100 is up since the referendum and is not a bellwether for the economy. On the other hand, the FTSE 250, which is considered a better barometer of the UK’s economic health, is down 10%. But there’s plenty of academic evidence that debunks the idea that there’s a correlation between equity indices and economic growth.
Sterling is down 12% against the dollar. But it has been overvalued versus other currencies for some time. The record current deficit of around 5% of gross domestic product (GDP) is a testament to this.
The suspension of trading of a number of open-ended property funds has led to comparisons with the collapse of Lehman Brothers**, which triggered a similar suspension of trading. But the trigger for suspensions then was banks cutting off financing to the commercial property sector.
That hasn’t happened. Rather, a rush of investors wanting to take their money out of these funds has made it impossible to accurately value the properties in the portfolio. Once one closes, it usually has a domino effect on the others.
Moreover, the world economy is very different from when Lehman Brothers collapsed. Reform of the banking sector has been extensive. These institutions have to hold much more, and better quality, capital than was previously the case. They can deploy that capital if the economy sours, but the fact they have it in the first place makes the economy more resilient. Central banks now test balance sheets for stresses, including those much greater than they currently face.
The Bank of England has been impressively proactive since the referendum, and for good reason. Brexit will hurt the economy in the short term. The danger now is that businesses stop investing and consumers stop spending. Investment and spending are the fuel in the economy, and without it the machine will grind to a halt. Some of it will probably be put off but how much, and for how long, will largely depend on what politicians do next.