In preparation for the general election next month, World First’s Chief Economist, Jeremy Cook, answers your most pressing questions on the outlook for the UK economy, sterling and global markets.
What is your outlook for sterling through the end of this year and into 2018?
JC: I’m not as bearish on sterling as I was at the beginning of the year, mainly due to issues outside of the UK such as USD weakness amidst the confusion of the Trump administration and the falling back of risks from European populism. Risks remain, of course, from the Brexit negotiations and damage done to the UK economy thanks to the fall in the pound. Although sterling has run higher on news of the election being called, this is mainly on the belief that Theresa May will thereafter advocate a ‘softer’ Brexit. Her campaign suggests otherwise.
What factors could impact sterling’s performance in the second half of the year?
JC: There are three main factors I think; what Theresa May does with any majority the general election affords her, how quickly Brexit negotiations around trade begin and how quickly the UK economy can acclimatise and change to a weakened pound, higher prices and weaker wages.
How well do you feel the UK economy is faring at the moment?
JC: It has become very clear that 2016 was a much stronger year than 2017 will likely be. 70-80% of the UK economy comes from consumption and the man in the street is being made poorer by inflation rising faster than wages. Meanwhile, businesses are dealing with margin compression. Exports are rising because of sterling weakness, but that won’t last forever and further growth needs investment which has fallen off a cliff since the referendum.
What do you see for the economy into the second half of the year?
JC: If business confidence increases and employers feel more able to increase wages then we could easily see a more positive second half of the year. However, I have doubts that this will emerge, especially given the lack of any certainty on how Brexit will actually be negotiated. The pessimistic view is that businesses whose margins have been compressed due to higher import costs and lower demand will have to cut back their workforce.
What are the possible outcomes of the election and what consequences could these have on Brexit negotiations and sterling performance?
JC: The markets are pricing in for one outcome only—a thumping majority for the Conservative Party. Polling suggests this is correct and that Theresa May could increase her majority from 17 to nearly 80. The reaction of sterling will largely depend on how well the Tory party does in constituencies that voted to leave the EU and by how much they wipe out the local UKIP vote. Should they do well then I believe that the pound may fall as investors increasingly price in a harder Brexit and more antagonistic negotiations. Similarly, large gains for anti-Brexit Liberal Democrats will be limited by the first past the post system of voting, but a protest vote against the government may be able to give sterling a drive higher.
Should businesses operating across-borders hedge or partially hedge their foreign exchange exposure (e.g. supplier payments, revenue repatriation)? Are there any methods you can use to help gauge what proportion of their exposure should be hedged?
JC: Always know where your budget rate is. Every business should know what price needs to be obtained for a given product line or service contract to be profitable and knowing a currency’s effect on that is crucial. Then determine, according to any internal risk appetite measures you may have, if and how you wish to hedge that risk away. Naturally, it will depend on your business and your ability to take on specialists.
It’s certainly worthwhile speaking with World First and using us as a sounding board. I’ve personally been in the industry for ten years and given most of those of years were spent navigating the risks of the credit crunch, Greece and now Brexit the team and I have a good amount of experience in the trenches!
What other global events may affect the broader markets this year?
JC: We’ve had two elections in Europe this year, but the German election in September is still to come as is the beginning of the Brexit negotiations. Similarly, while the US election was last year the back and forth of the Trump administration’s ability to get anything done will generate a huge amount of uncertainty over the US dollar. It has all gone quiet in China as well…but for how long?
What impacts could Trump have on the markets/global economy?
JC: It may seem like Brexit is the most important thing in the world right now, but it isn’t even the most important issue in Europe. So much of the market moves of 2017 were predicated on a strong and stable Trump administration and the ability to make meaningful changes to laws on healthcare, tax and trade. Given the current inability for US politicians to multi-task, the focus is on the increasing scandal around the firing of the FBI Director and the part Russia played in the election. The longer the delays to the reforms priced into markets, the more of an effect Washington will have.