It's a two horse race ... and they're off ...

It’s a two horse race to be the next Prime Minister of Britain. Gove is a goner. Osborne gone missing. Theresa May versus Andrea Leadsom the run off. We can but hope the race will be over soon and we can get on with doing - whatever it is we are going to do …

It is too early to understand the impact of Brexit on the UK economy. It could take five years yet. Some believe we may never get to know. The hope, a deal may be struck before the end is nigh. A sort of three for four deal. Freedoms on trade, services and capital with restrictions on immigration. All this without a contribution to EU coffers. An end to the Nanny State. An end to euro regulation and bureaucracy. Well good luck with that.  We are handing in our Article 50 notice before the end of the year. Team EU are forewarned and are already taking evasive action.

The referendum is impacting on the UK economy …
The referendum decision is impacting on the UK economy, in ways in which were expected.  Sterling has fallen against the Dollar and the Euro. Markets have reacted to the downside with the broader FTSE 250 in decline. Consumer confidence has taken a hit. Car sales are lower in June. High Street sales will slow further.

Retailers are complaining about the impact of sterling’s fall and higher prices in store. Economics models suggest a 10% fall in sterling will lead to a 2% - 3% rise in consumer prices over the next few years. The models are dated, unlike the real time line action. Inflation will begin to rise pretty quickly. There is little scope for margin absorption in the manufacturing, wholesale or retail channels. The impact of sterling’s decline will impact before the end of the year, compounded by a rise in dollar denominated oil and commodity prices.

Property funds have been hit …
Property prices in the South East have been hit. Commercial real estate confidence has been damaged by the “gating of funds”. Major funds including Aviva, M&G, Standard Life, Henderson  have stemmed the flow of withdrawals by shutting doors and marking down prices. Bold moves isolate the threat to the financial system.  Time for investors to reflect on fundamentals. Confidence will return and prices will recover.

Investment plans are subject to revision.
Sectors at risk are banking and financial services in London; Motor manufacturing across the UK and in the North East particularly; JP Morgan threaten to leave London. Paris and Frankfurt will compete to entice relocation for London’s big players.

We expect a negative impact on aerospace, chemicals and big Pharma but not for some years yet. Ironic this week Tata steel announced a possible deal with ThyssenKrupp. The steel industry dependent on imports of ingots and coke to feed the furnaces will not benefit from the vagaries of currency.

So what of trade … and the other two horse race …
This week the ONS released trade figures for the UK economy. The deficit trade in goods increased in May. For the year as whole we expect the trade gap to increase to £130 billion this year. There will be no trade amelioration as a result of sterling’s decline. [As we have explained at some length and for many years.]

The current account deficit according to the ONS was 7.2% in the final quarter of 2015 and 6.9% in the first quarter 2016. The Bank of England has warned that the UK’s large current account deficit poses a threat to financial stability. The UK is financing this deficit by an inflow of foreign investment  - if investors lose their appetite for UK assets they will demand higher risk premia, pushing up the financing costs for the deficit.

No real evidence of a gilt strike so far. Ten year yields have fallen below 1%. The governor is threatening to cut base rates still further. The move would undermine, not support sterling and do nothing to encourage positive capital flow. Current account deficits of such dimension, have never been experienced before in our post war history and never on Planet ZIRP with base rates at 0.5%.

Over in the US, payroll numbers increased by 287,000 in June. The Fed indecision about the rate rise may be eased by the news. The Fed is likely to move in August placing greater pressure on Sterling. The next move for the Bank of England should be to push rates higher.

So what happened to Markets?
Sterling fell against the Dollar to $1.296 from $1.326 and down  against the Euro at €1.171 from €1.191. The Euro fell against the Dollar to 1.105 from 1.113.

Oil Price Brent Crude closed at $46.82 from $50.15. The average price in July last year was $56.56.

Markets, were up - The Dow closed up at 18,120 from 17,954. The FTSE closed at 6,590 from 6,577.

Gilts - yields moved down. UK Ten year gilt yields closed at 0.73 from 0.86. US Treasury yields moved to 1.37 from 1.45. Gold closed at $1,352 from $1,335.

John

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