I tweeted this the other week but thought it might also be useful to plonk onto the website. An annotated chart of the pound vs the US dollar over the past few centuries. Click on it for a bigger version.
That was how long the Chancellor’s message of reassurance to market investors lasted today.
George Osborne resurfaced at the Treasury just after 7am to tell investors that the UK economy remains strong, to assure them and households that he would take all necessary contingency plans to deal with the instability following the Brexit vote.
And for a little while, the plan seemed to go pretty well. The main London stock markets did not start the day quite as low as had been expected. The pound even rose, for a bit. Moreover, there has been no sudden stop, where investors abandon a government’s debt. In fact the UK government can now borrow at the lowest rate since 1703 – less than 1% for 10 year debt.
But a little after 9am the effect wore off and the market misery that characterised Friday’s trading was back.
London shares slumped back towards the 6,000 mark, with bank shares and a few of those most affected by Brexit doing disastrously: RBS (still 73% owned by the taxpayer, lest we forget) was at one stage down by 25%; Easyjet was down by a fifth. Having risen briefly after Mr Osborne’s appearance, the pound then dropped again to the lowest level in 31 years.
Credit Suisse said that based on leading indicators, the UK is probably already in recession. Indeed, the way investors are behaving – piling money into “defensive” stocks such as utilities and consumer staples – suggests they are gearing up for a slump. The Institute of Directors warned that businesses were actively considering pulling investment and cutting jobs from the UK. Investors are now betting that the Bank of England will cut interest rates in the coming months, perhaps more than once.
Moreover, looked at from another angle, those record low gilt yields could equally be taken to imply that UK growth will be weaker for longer.
Ugh. And, frankly, the bad news is likely to outnumber the good for some time – and for a simple reason. Investors demand stability: stability of taxes, of trade arrangements, of regulation, of immigration policy, of exchange rates. They all play a part in determining whether a company will build that new factory or hire new workers. And the problem with the way Brexit has manifested itself is that, having won the referendum, the Leave campaign is looking towards the Treasury for a plan, who in turn are looking back towards the Leave camp for a plan.
The Chancellor’s appearance this morning illustrated the problem perfectly. There is, he said, a short term plan for stabilising the markets. What there isn’t is a long-term plan for the kind of relationship the UK wants with the EU and other trading nations. And one presumes there won’t be such a plan until there is a new Conservative leader and, perhaps, until after a general election. And even that might not provide a clear guide, since there may not be a clear majority winner.
You get the idea. As long as there is no plan, instability will reign. Investors will continue to be wary of the UK economy, and the economy will be sluggish. The only question is how long the sluggishness, or indeed the potential recession, will last. Another way of putting it: how long until the politicians get their act together, stop squabbling and start leading?
The frustrating thing (well one of the many frustrating things) about the EU referendum campaign is that all too often some of the numbers spurted out by both sides simply aren’t interrogated.
There are a few eye-catching exceptions: the Government’s claim we’ll all be £4,300 worse off; Vote Leave’s EU-costs-£350m-a-week. But many of the other claims are just trotted out without much challenge.
Take Boris Johnson’s recent claim that the UK will be landed with a £2.4bn bill as a result of rising EU budget contributions. This is misleading on two counts: first, because UK contributions always rise as the broader economy expands (they are a constant chunk of an increasing pie). Second, because extra budget contributions on top of this can be vetoed by the UK.
Or take another claim I’ve spent the day trying to get my head round. This one:
This isn’t the first time we’ve heard a warning from the Remain camp that mortgage costs could go up in the event of Brexit. But it is the first time they’ve put some numbers behind it. And yet if you go to their website to try to find out how they got to this £900 figure, you’ll find just two paragraphs with no statistics and no real explanation.
Now, they did send out a press release to lucky journalists with the following bullet points:
Much of which you’ll have seen cut and pasted into news stories in the papers over the past few days. Unfortunately none of those stories point out a few critical problems with the £900 figure.
Before we get to those problems, allow me to explain how they get to that number in a few bullet points.
- They take the calculation in the Treasury’s paper on the short term impact of Brexit that if the UK left household borrowing rates would go up by between 70 basis points and 110 basis points, which is the same thing as saying 0.7-1.1%.
- They then take the average house price, as of March, which was £292k, they assume that people will be taking out a 76% mortgage on it (in other words a £222k mortgage).
- They then take the average two-year fixed interest rate on a new mortgage, currently 1.87%, and worked out, using the Money Advice Service’s mortgage calculator, how much a 1.87% repayment (eg not interest-only) mortgage would cost each year (£11,123) and how much that mortgage would cost if the interest rate were 2.57% (£12,045)
- Voila, they have a figure of a difference of £922 a year.
But there are quite a few problems with this analysis.
- It is not a given that mortgages would go up by precisely the same amount as the “household borrowing rate” referred to in the Treasury report. Even if you buy the HMT analysis (and some economists do not), unsecured lending rates typically bounce about less than other forms of lending.
- The average outstanding mortgage in the UK is not £219k but £101k. Use this figure as your starting point for the same sums above and you get an increase in average mortgages of £430 a year, or just £35 a month, which sounds significantly less scary.
- The fact is that a 0.7 percentage point or even a 1.1pp increase would still leave mortgage rates well below much of their historic levels. You can see that from the following chart:
On top of this, one could also point out that were there to be a post-referendum recession, the Bank of England could plausibly cut interest rates, which is not something accounted for in the above working.
Finally, recall that the Treasury have also projected a fall in house prices in the event of a severe shock. If one is using the same methodology, that would also reduce the implied mortgage cost (lower house price = lower loan = lower mortgage repayments).
None of this is to dispute the likelihood (and it is a likelihood) that there would be at least a short term economic shock if Britain left the EU. But the Remain camp do themselves no favours by trying to depict this as a major mortgage shock, especially given the opaqueness of their sums.
Strange as this might sound, under the Treasury’s post-Brexit economic model it’s conceivable that the UK economy could, for a period, grow faster outside the EU than inside.
Let me explain why.
If you were reading this blog yesterday you’ll recall my point that the Treasury had not drawn up a simulation of what could happen to the economy if the UK left the EU and stayed in the single market.
For those who didn’t see that story, a quick recap: back when the Treasury published its analysis of the long-term impact of Brexit, it considered three scenarios of what might happen after Britain left: 1. That it stayed inside the European Economic Area (the EEA or single market), 2. That it left and agreed a bilateral trade deal with Europe (the Canada option) and 3. That it left and simply relied on World Trade Organization rules to trade with Europe and everyone else. The economic impact of each deal was as below:
However, when the Treasury published its short-term analysis yesterday, looking not at where Britain could be in 2030 but how it could do between referendum day and Q2 2018, it only provided two scenarios: a “shock scenario” where growth fell 3.6% and a “severe shock” scenario in which it fell 6%.
As I wrote yesterday, the two scenarios were both based on the presumption that the UK would not join the EEA – in other words the least negative option from the top table above was simply ignored.
The suspicion was that this most conservative option was omitted because the scenario would not result in the scary recession the other scenarios projected.
However, I’ve since been told by government insiders that, in fact, something similar to these two scenarios – the shock and severe shock – could nonetheless apply even if the UK left the EU and then eventually decided to stay a member of the single market. In other words, a small or even deep recession could ensue whatever post-EU path the UK decided to take. This is because there are three factors that could cause a recession: the uncertainty factor (people get scared), the transition factor (people make particular plans because of how they envisage life will be outside the EU) and the financial market factor (the City faces big trouble following Brexit). It turns out the uncertainty factor is one of the biggest elements- and that would apply whatever post-Brexit path the UK takes.
On the one hand, Leave campaigners will see this as a blow. People are generally unlikely to vote for economic pain, after all. However, there is a thin, albeit hollow and technical, silver lining for them, which goes as follows: if the UK leaves the EU, suffers a severe shock and then opts to remain a part of the single market, according to the Treasury’s own models it could actually grow faster for the following decade and a bit than it would had it simply stayed in the EU.
How does this work? Well, 1) let’s presume the UK had that severe shock and shrank by 6% between Q2 2016 and Q2 2018 compared with its path if the UK remained. 2) Assume, too, that the Treasury’s long-term assumption stands, that if the UK took the EEA route then by 2030 it would be 3.8% smaller than if it stayed in the EU. 3) In that case, the economy would need to recoup some of that lost ground in the following years. In rough terms, one might expect that between Q2 2018 and 2030 the UK economy could grow 2.2% faster than it would do if it stayed in the EU.
You can see the point from the line in the below chart, which compares how UK GDP would fare compared with its current expected path (the zero line). As you can probably tell, I jotted in the line myself:
In other words, on the basis of the Treasury models, the UK economy would be smaller in 2030 than if it stayed in the EU, but there would also be what Gerard Lyons, Boris Johnson’s economic advisor, has called a “Nike swoosh” effect as it regained some of that lost ground in the following years. What this means in practice is that the economy would grow ever so slightly faster between 2018 and 2030 than it would if the UK stayed in (perhaps 0.2 percentage points a year, which is pretty small in the grand scheme of things).
Moreover, it’s something of a Pyrrhic victory, since the growth comes from a smaller base and the UK economy would, on this basis, nonetheless be smaller in the long term than if it stayed inside. Plus, Treasury insiders say there’s also a significant chance that if the UK suffered a major recession in the first few post-EU years, then the 2030 end-point could be even worse than it thought in last month’s analysis.
Finally, you could, quite reasonably, retort that this is just proof that you can use an economic model to prove basically anything. Which is quite right. So why are we paying so much attention to them in the first place…? etc etc
If you follow these things, you may recall that last month, when the Treasury produced its analysis of the long-term impact of Brexit, it furnished us with three potential scenarios: 1. that Britain leaves the EU and remains in the European Economic Area (the EEA, or single market), a little like Norway; 2. a bilateral agreement option (a bit like Canada) and 3. following World Trade Organisation rules.
You probably recall that the EEA option was the least damaging, with GDP in 2030 3.8% weaker than it would otherwise have been, followed by the Canada option (-6.2%) and the WTO scenario (-7.5%).
Roll forward to today’s short-term analysis of Brexit and you might have noticed that there are only two scenarios mapped out by the Treasury. There is the “shock” scenario, which projects a 3.6% hit to GDP over two years (relative to where it would be otherwise), and the “severe shock” scenario which projects a 6% hit.
As you can see from this chart, the “shock” scenario is based on the Canada path in last month’s paper. The “severe shock” scenario is based on the WTO path (you’ll notice that the colours correlate, and this is not accidental).
But there is no line to simulate the EEA option.
This is odd. For while many members of the Leave camp have indicated that they would not want to remain inside the single market, this is hardly a final decision, and is, for many, still the most likely option.
Either way, it is odd and inconsistent for a respected institution like the Treasury to simply change the terms of its analysis so abruptly. And it leaves one wondering whether the short-term impact of the UK leaving the EU and following the Norway path might actually not be all that harmful at all.
Might it have excluded the Norway option because, dare I ask, it didn’t result in a recession at all?
PS I’ve written a longer piece of analysis on the Treasury document on the Sky News website