After quite a week for the United Kingdom we take stock of where we are. It seems that we won’t know for some time what shape the UK’s reformed relationships will take. So, for now, we can only assess the impact of uncertainty – including a weaker pound – and look at the pinch points and opportunities by sector. This is a complex and nuanced picture – with some potential bright spots, as markets are starting to acknowledge.
The uncertain impact of the long goodbye
It’s still tough to know how to react to the EU referendum result given the long path that now lies ahead. All the rules and regulations are the same as they were; but – at an indeterminate time in the future – they may change dramatically or may-be more subtly. No-one can say. So what we’re seeing now isn’t the impact of BREXIT per se, just the impact of uncertainty – primarily via confidence and sterling.
The pound was always set to feel the brunt of trading and investment concerns given the UK’s sizeable current account deficit. Not unsurprisingly, June has turned out to be the worst month for the pound since the financial crisis. It’s a little more complicated in equities. The initial sharp and universal drop reflected the reversal of a significant bet on the UK remaining within the EU. The response has become nuanced as the week has gone on and support has arrived. The FTSE 100 has finished up on the month, which isn’t surprising in the context of a weakened pound, the index’s international profile and the now likely delay to US interest rate increases. The more domestic-oriented FTSE mid-250 has had its worst month since May 2012 – although it is up from earlier lows.
We could read a lot into this differential, although it’s too soon to badge this as an entirely localised event. This is still a fluid situation. International markets will remain sensitive due to the lack of global growth and limited policy manoeuvre for central banks should they need stronger remedies.
A sector view
So what are the specific potential pinch points – and opportunities –in this world of post-BREXIT uncertainty and how do these relate back to sectors?
(Always keeping in mind that in some sectors, what’s bad for the goose in isn’t always bad for the gander)
Contracts and investment
It is impossible to generalise the corporate response given the variety of challenge and opportunity and differing reactions to the long run into change. On the one hand, it offers a long period for some companies to plan and to trade normally in the interim. On the other, it’s a long time to wait for certainty in regulatory, trading and investment environment. From what we know from other periods of uncertainty, Support services companies – with their high reliance on B2B spending and the contract cycle – will feel any pullback in confidence and spending first. Recruitment industry body REC said that its data had shown a slowdown in hiring ahead of the vote and that there would be a challenging period ahead – even before they deal with changes to recruitment from outside the EU.
Other sectors with strong links to investment activity – capital goods, software and real estate – could also feel the pinch in demand.
Any fall in economic activity will invariably hit government finances, but we don’t yet know the magnitude or how this will relate to spending – austerity or stimulus? Nevertheless, we can probably assume that there will be a substantial reprioritisation, given the magnitude of the task ahead. This leaves a period of uncertainty for industries heavily tied into the public sector, such as outsourcers or infrastructure companies. The healthcare sector is under many existing pressures, but may be more protected from further changes. We also know from past experience, that there is always a role for those who can offer ways to assist in transitions and those who can add value and limit costs.
The Financial services sector itself is probably the area of greatest uncertainty in the UK economy. We believe that the UK sector has a great deal to offer, but clearly there are significant regulatory issues up in the air and concerns over the general economic outlook– more on which <here>. As decision making is put on hold – and if uncertainty build around relocations – this could have an impact on London real estate.
According to a YouGov/CEBR poll, UK consumer optimism dropped to its lowest level since May 2013 in June. The uncertainty of a leave result for economic activity and jobs could hit consumer-oriented sectors like retail, house builders, estate agents, media and travel & leisure; although there are mitigating demand factors. Uncertainty could deter some house buying and dent the lure of London for foreign buyers, but the cheap pound and strong underlying demand could provide a cushion. Consumers’ prioritised spending on the family holiday during the financial crisis – less so for the casual weekend away. This suggests continuing support for some parts of the travel sector, but challenges for airlines who also face changes to regulations. And in all of this we mustn’t forget life before BREXIT and the other factors in play – like geopolitical, competition, pressure on prices etc.
The majority of retailers’ operating costs are located in the same country as they generate sales, but most goods originate from overseas with payment in dollars or euros. The euro is not immune to BREXIT pressure itself so might not rise significantly against sterling. But the pound has flirted with generational falls against the dollar, which will add to supply chain costs. Some of this will be phased due to hedging – as is the case for most sectors who buy heavily in dollars and where the currency impact could be delayed. Construction and food producers similarly may source much of their raw material from outside the UK.
Currency translation & exports
The falling pound obviously has a silver lining for companies across a variety of sectors who do the majority of their business outside of the UK, such as pharmaceuticals, luxury retailers and miners. Those with local operations will benefit from positive currency translation and exporters could benefit from increased demand. That said, recent experience suggests that the weak pound is a mixed bag for manufacturing. High value items will be more sensitive to demand than price and many companies will also buy in materials or components from outside of the UK. This could limit the benefit of the weaker pound – especially when you add in any increase in energy costs.
And beyond current uncertainties…?
That’s the literally billion dollar question. What we do know is that few changes are likely to happen overnight. As a result, businesses have a good opportunity to take proactive steps to prepare for the challenges and opportunities that lie ahead. Companies need to start thinking about changes to regulation, the impact on their labour force of any changes to freedom of movement and on distribution and logistics given the potential implications from trade tariffs.
Companies may start need to start thinking about their portfolio in this context. Given the fall in the pound, it’s possible that buyers might come knocking in the UK when the dust starts to settle – or before, if valuations look attractive enough. This is all about how companies manage change and the winners will be those who can move with greatest speed and ease.
We’re holding a webcast on Friday 8 July to discuss the latest EY ITEM Club forecast and the impact of BREXIT. Please join Peter Spencer, Chief Economic Adviser to EY ITEM Club and Mark Gregory, EY Chief Economist from 08.15 – 9.00