A forecast of the British economy in the short to medium term, by anyone’s standards, would be bleak. The inflation, energy crisis, and Brexit have placed the country’s economy in an unenviable position. Last week, the government announced new measures to fill the budget deficit with a £55 billion fiscal squeeze as the inflation reached a 41-year high at 11.1 percent.

Some of the challenges we have witnessed in recent times, have been global and faced by many other countries. Be it the global recession of 2007-2008 or the Covid pandemic, most of the leading economies have come out of such challenges with a different-looking economic health card than the UK. So, what is so different about the UK?

Office for Budget Responsibility recently stated that ‘Brexit’ has had a severe adverse impact on UK trade. We have already seen irreversible damage to the British financial industry where the EU business was taken out of the UK, 7000 of the jobs moved to the EU. It is no wonder that the Paris stock exchange is now the largest stock exchange by market capitalisation in Europe, displacing London. It remains to be seen if London can hold on to its dominance in the clearing market – especially for Interest Rate Swaps (IRS) clearing.

A large percentage of the Euro as well as sterling IRS business was moved from the Europe and UK to the US last year – a business that is worth trillions of dollars – as the US was given third-party clearing status, again ignoring the U.K.

London Clearing House has also witnessed a declining trend in terms of IRS notional, from $1.23 quadrillion in 2019 to $0.985 quadrillion so far in 2022, as of 17th November. While London still leads the rest of the global markets in FX trading and IRS but the change in trend is noticeable since Brexit. New stock market listings in London have been down and declined further in Q3 2022 with only eight listings compared to thirty-three for the same period last year with the funds raised being down from $4 billion to £565.5 million during this period. FTSE levels are also forecasted to stay below the 2021-22 levels for the next 3 years.

Brexit, the energy crisis led by the Russia-Ukraine war, and rising inflation have induced an economic environment where it does not seem to be an ideal time to ween off the country from the addiction to Quantitative Easing and low interest rates. But the rises in interest rates have been inevitable for some time and are likely to rise further than the current rate of 3%. There was no other substantially viable option at this stage for the economy to be brought back on track other than to find measures to fill the fiscal deficit.

So far in 2022, the Bank of England has consistently raised interest rates in tandem with the Federal Reserve, and in the latest move, they have mirrored the Fed’s 0.75 percentage-point rise in September. This rises in the interest rate, totalling 2.75% since the beginning of 2022 has left the public finances more vulnerable to future shocks or swings in market sentiment. If any extra spending by the government is financed through higher borrowing, the Bank of England would react further.

As a consequence of the squeeze on real incomes due to high inflation, rise in interest rates,and fall in investments the British economy has been tipped into recession. But the increased rates do not just pinch borrowers, they also affect the government itself. For over a decade since the global financial crisis, government debt interest payments fell steadily which was the result of low interest rates as well as Quantitative Easing (QE). But now, with the rising rates, the debt interest cost will more than double this year to reach £120.4 billion or 4.8 percent of GDP, as compared to last year. An interesting comparison shows that the similar debt costs for the US national debt are projected to be $399 billion (£338 billion) for 2022, but that is only 1.6% of the US GDP.

The much-promised fruits of Brexit might crystallize in the long term but in the short to medium term, this economic fragmentation only seems to have brought sluggish growth for the economy, recession, and a squeeze on real incomes. The negotiations with the EU and new trade deals with the important economies will be long and arduous as we have seen in recent years. It would not be unfair to suggest that the UK economy and the markets are currently on a sticky wicket and the autumn statement by the chancellor is only a first step to avoid the economy falling into entropy.

References:

  1. Office for Budget Responsibility
  2. Bank of England.