By Christian Richter
Professor of economics at the German University in Cairo.
Almost a month, after the Brexit referendum. Politicians all over Europe still try to come to terms on it. Nobody really had a plan for the leave option. The political landscape in UK is still unsettled. The Tories found a new leader – Teresa May – and remarkably has not really said what “Brexit” actually means apart from leaving the EU. So anything is possible from the “Norwegian model” to a full exit with no access to the single market. On Labour’s side Jeremy Corbyn’s position as leader is in doubt as well as MPs blame him for an inefficient remain-campaign. As he is fighting for his political survival he points out that Labour has now more members than ever in modern history (more than 500000). Meanwhile, the UK exchange rate is falling against all major currencies. Today the Euro it is at EUR1.19 (after a low of EUR1.16) for one pound where half a year ago it was at EUR1.33. Of course, the exchange rate reflects the political uncertainty caused by the referendum, but also an increased lack of trust domestically as Brits are increasingly buying gold driving up the gold price. The price for an ounce of Gold rose from $1257 to $1366 as of today.
As the pound devalued on the foreign exchange markets, Legal & General, Foreign & Colonial and Dutch-owned Kames cut the value of their property funds. L&G cut the value of its £2.3bn fund by 10% on 7 July, the second cut after a 5% cut the week before. F&C and Kanes both cut by 5%. Aberdeen Fund Management announced on 6 July it was halting trading in its property fund for 24 hours and devalued it by 17%. It is thought to be the biggest adjustment ever made by a property fund. Aberdeen has since extended the trading ban until 11 July. Others have suspended dealings for longer, starting with Standard Life’s decision on Monday to halt trading in its £2.9bn commercial property fund, leading to a cascade effect with Aviva, Prudential’s M&G, Henderson, Columbia Threadneedle and Canada Life following suit – taking the total value of property funds suspended to £18bn. Some estimates are that commercial properties worth £3-5bn could be put up for sale. One wonders who is going to buy it, given that consumer confidence is on an all time low?
Of course, a fall of the pound will also lead to imported inflation as the UK’s current account is in deficit for years. For example, Dell increased prices by about 10% and the price for petrol rose by 2.5p since the referendum.
Moreover, on top of the problematic break up with the EU there is now a referendum looming on Scotland’s independence and maybe on Northern Ireland as well. Meanwhile the old argument with Spain on Gibraltar is breaking out again. If the UK would like to join the single markets it needs approval from all EU member states. That gives Spain leeway to negotiate over Gibraltar’s future. As a result the UK’s territorial integrity is at risk which could result in political turmoil as well.
Angela Merkel just re-confirmed that there will not be any pre-negotiation on the Brexit. Negotiations only start when Britain triggers Article 50 of the Lisbon treaty. So, for as long as the UK is not triggering Article 50 and for as long as negotiations will take place over the future relationship of the UK with EU there will be great uncertainty as investors will not know whether they will have access to the single market from UK. Therefore, the UK is negotiating from a weak position.
Hence, banks are already reacting and moving to continental Europe, Brits are now remembering their Irish roots. Applications for Irish passports (estimates say that up to 25% of Brits care eligible to apply for an Irish passport) are on a record high. So high that post offices ran out of application forms. Investors are also moving out (see above). So it seems leaving the EU also means that people and institutions leave the UK.
Apart from job losses in the financial sector, the other big exporter, namely higher education is suffering from years of under-funding. The Higher Education Funding Council published a financial sustainability report in March this year, which comes to conclusion that the Higger Education (HE) sector is not financially sustainable. As an example, University College London announced that they only have cash flow for 42 days left. On top of this, the Brexit in the HE sector means a loss of research grants worth around EUR1bn of which Oxford University was the biggest benefiter. So job losses in the HE sector as well as mergers/closures of Universities can be expected.
Moreover, rating agencies have downgraded UK government debt with the prospect of further downgrades. This will make it more expensive for the government to borrow money. However, at the moment, investors shift from the stock markets to gilts making the return on gilts negative for a short period of time.
All of this is, of course, circumstantial evidence. A lot is still unknown, but taken together, then it becomes clear that London is about to lose her status as the EU’s financial centre. The Higher Education sector will see a lot of re-structuring. Foreign companies are reviewing their investments in UK.
No doubt, the UK is going through turbulent times. Nobody knows at this point in time for how long this uncertainty will last. Likewise, with this uncertainty an economic recovery is unlikely. If negotiations take two years (or longer) then this is a long period of uncertainty which for sure will have negative consequences on the real economy. If at the end of this period there is no agreement, then the UK may well lose 50% of her exports with further implications on the real economy. All of this is no good news for any economy.
What does this mean for the Middle East? As far as oil imports are concerned, they will continue, although with the devaluation of the pound eventually demand may decrease. From an investment point of view, as for all investors, the UK looks like an unattractive place to invest. Access to the single market is in doubt and existing capacities in UK are enough to cover the domestic market. Access to other markets are at this point in doubt as well. Students from the Middle East are not affected by the Brexit as their visas were given by the British government which is outside EU’s Schengen agreement. The same holds for Middle Easterners currently living in UK. Of course, in the government’s drive to reduce immigration the visa practice may be changed.
As the recession gains path, imports from the UK will naturally decline. So the domestic market is shrinking making UK investments even less attractive. This will also be reflected in the stock market which so far did not really decline (apart from the blip just after the referendum result was announced). The new government under Teresa May will certainly look at ways to stimulate the UK economy, but the means are limited given the previous austerity measures.
One piece of good news is that the weak pound is appreciated by tourists who plan to visit the UK.
All in all, any sort of investment in the UK carries a large risk premium and it is uncertain for how long that will continue.
