Edition 11 - Economics & Markets

Britain in the wake of its big, bold move on the global stage

If it wasn’t for COVID-19, the most important geo-political event in 2020 would have been Britain’s exit from the European Union. In the wake of a brutal pandemic and political upheaval, Britain is facing a very different future.

Instead, the most significant parting recent decades has gone relatively uncommented. What have been the consequences? Was it a success? Has the British economy collapsed as naysayers predicted?

There’s no clear answer because so much economic activity across the global has been swamped by the coronavirus pandemic and its impact. But the early signs are that Brexit has possibly benefited the UK.

Perhaps more accurately, some European economies have been hamstrung by being part the Union in these unprecedented times. And that’s not something the UK has had to worry about.

One way to think about it is through the prism of fiscal policy response and COVID-19, says Diana Mousina, senior economist at AMP Capital.

“There’s a central block for the Eurozone controlling all economies,” Mousina says. “But what countries need is greater flexibility around individual governments having more say around budget deficits and debt to GDP levels.”

Weaker economies such as Greece, Spain and Italy, have been tied to rules about keeping a cap on debt levels. They haven’t been able to devalue their own currency to boost economic growth.

“Britain was never quite as tied into the economic policy-making of Europe, even before Brexit. It still issued its own currency which was wise,” Mousina says.

“Today in the UK, along with Australia and the US, the government is issuing huge amounts of debt which has been financed by the central bank printing money. Individual European countries whose currency is tied to the euro can’t do that as easily.”

The single currency across the Eurozone has not worked for many countries.

“Countries can’t use their own currency to improve economic outcomes,” Mousina explains. “Countries that are struggling like Italy, Spain and Greece … need a cheaper currency to compete in the global market.”

The euro has appreciated sharply over the past 12 months again the US dollar, notwithstanding it has come off its peaks in the past couple of months. Appreciating currencies act as economic handbrakes.

“The euro has been performing well because Germany is a huge exporter in the global market,” Mousina says.

“The region’s largest and strongest economy has benefited from having a weaker currency than it would have had otherwise. Germany runs a very large current account surplus which tells you its currency would be more elevated if it were trading on its own terms.”

While being independent of Europe may be advantageous to Britain in the future, it hasn’t meant the country has done better than the rest of Europe.

Britain’s growth rate last year during the pandemic compared poorly to the Euro area and was close to some of the worst performing European nations. But it was difficult to tell whether that was a function of Brexit, the pandemic, or something else.

“It’s really quite difficult to see how Brexit has changed the economic backdrop in the UK because of the pandemic,” Mousina says.

“COVID is the biggest driver of the economy in the UK and Europe, so it’s hard to read the data and see the impact of Brexit. Is growth the result of the pandemic or the result of the UK leaving Europe?” she asks.

Because individual countries in Europe can’t devalue their currency to kickstart their economies, other reforms are needed in the Eurozone, Mousina says.

“They need to come up with some form of deposit insurance scheme. They need to strengthen their international institutions and they need to make people more accountable for their decisions around the financing of budgets. At the moment, the situation is not very coherent.”

“There has been some improvement in recent years. The unemployment rate has come down a lot in the region, for example. But in some individual countries like Greece and Italy, there are a lot of problems in areas like youth unemployment and the banking sectors,” she says.

More recently economists have cut growth forecasts for the region as the third wave of COVID-19 hits Europe. Delays in the roll-out of vaccinations have triggered further tightening of restrictions in major economies including Germany, Italy and France.

Forecasts that the European Commission made in February say that the near-term outlook had deteriorated as the pandemic tightened its grip on the continent. It forecast growth for the EU of 3.7 per cent this year, and 3.9 per cent next year. By the end of this year, some member states will reach pre-pandemic output levels. But others, particularly those reliant on tourism, would take longer. Inflation was likely to remain subdued1.

In the United Kingdom2, the Bank of England said that economic growth was expected to recover strongly over 2021 back towards pre-COVID levels. But unemployment was tipped to rise during the next couple of quarters. Britain started this year with GDP still about 10 per cent below its pre-pandemic level3.

Growth rates in the region have real importance for Australia. The United Kingdom is the significantly bigger trade partner of the two. It takes 4.2 per cent of Australia’s total exports, including gold, wine, lead and pearls and gems. The EU takes three per cent of exports, including gold, coal and oil seeds4.

While it is too early, and too difficult because of the COVID-19 impact, to judge the success or otherwise of Brexit, Mousina says that many of the concerns voiced initially may prove unfounded.

“If Europe goes down the path of continued slow growth, that would have impacted the UK, because even though the UK wasn’t part of the Eurozone, it was part of the European Union and it would have been impacted by some of the rules in the EU,” she says.

“Also, the UK would have had to make a big contribution to the European budget, and they would have had less say in the services the money was spent on.”

Another benefit of Brexit, it seems, has been in the roll-out of the COVID-19 vaccine. “One of the benefits of Brexit, potentially, has come with the vaccination of citizens. The UK has vaccinated a large portion of its population. If they were still part of the European Union, I’m not sure they would have been as successful,” Mousina says.

“They have been able to act more independently. I don’t think they would have been able to do all the vaccine production that they’ve done onshore if not for Brexit,” she says. “Europe is clearly having issues, organising its supplies, and its redirecting supply to Australia and the UK to get its own vaccinations going.”

For Brits, some of the more pessimistic forecasts of economic disaster post Brexit haven’t eventuated.

“When Brexit happened people were worried about food shortages and supplies in supermarkets. But it hasn’t actually happened. Some regulation around fresh food has been a bit of a problem because it is more time consuming and fresh food is getting stuck in trucks. But that is probably just a teething issue,” Mousina says.

But it’s not all positive.

“The services component of UK exports to Europe could be an issue, particularly for financial services and insurance. For example, openings in finance jobs in London have been declining. Amsterdam recently took over from London as the biggest share trading centre in Europe. We need to be careful interpreting the figures because of the impact of COVID, but it is interesting that they have declined,” Mousina says.

While the UK may have benefited from not having to follow EU rules, many weaker economies in Europe are suffering, Mousina says. “That’s what make me question the future growth of the Eurozone. The medium-term average for Eurozone GDP growth has been two per cent which is very low,” she says.

“Productivity growth is extremely low. Youth unemployment in some countries is extremely high – 30 to 50 per cent – which is just unacceptable. And there’s issues with population outflow because there’s no future for some of those people."

The inflexibility of the rules that come with being in Europe, post pandemic, seems to outweigh the benefits of being part of a trading bloc. And by good fortune or management, Brexit doesn’t appear to have had overly negative consequences.

And Mousina’s final word: “I think the concerns about Brexit in the UK may not actually turn out to be as bad economically as anticipated.”

Important Notes

While every care has been taken in the preparation of these articles, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in them including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. Performance goals are merely goals. There is no guarantee that the strategy will achieve that level of performance. The information in this document contains statements that are the author’s beliefs and/or opinions. Any beliefs and/or opinions shared are as at the date shown and are subject to change without notice. These articles have been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. They should not be construed as investment advice or investment recommendations. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

Edition 11 - Economics & Markets

Turn down the noise to understand what’s happening in the bonds market

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