Is too much golf really the cause of the UK’s poor export performance?

The problem with UK goods exports is not to be found on the golf course –performance will only improve if business and government work together.

UK exports: a consistent story of failed ambition and declining market share…

In picking up on Liam Fox’s recent comments,  Andreas Whittam Smith is right to question the quality of the UK’s export performance. It has certainly fallen below aspirations. In 2012, in setting out his ambition to double UK exports to £1 Trillion by 2020, the then Chancellor of the Exchequer threw down a gauntlet to British exporters. At the current time there appears almost no chance of the UK achieving this target: the EY ITEM Club summer forecast suggests that £660 Billion is the likely level of exports in 2020.

The failure to achieve this target should come as no surprise. The story of UK exports is one of a continuing long-term decline in world market share. The UK accounted for 10% of world exports in 1950 but this had fallen to 3% by 2009. Yes, other developed countries have lost market share too, but not at the rate that the UK has done so.

…but the average hides the true story: the UK is world class at exporting services…

Liam Fox and Andreas Whittam Smith are wrong at least in part: the UK is a world leader in services. UK exports of services have grown impressively in recent years as the UK has been successful in selling to the world’s largest and fastest growing markets. The UK has world leading capability in financial services and business services but is also able to generate a positive trade balance in a number of other service sectors. By contrast, although there are pockets of success, the UK has found it much harder to succeed as an exporter of goods.

…because we have a very strong domestic services industry…

One stand out difference between services and goods is the stronger domestic position of UK based services companies. The UK has a thriving services sector and UK companies are strongly represented in the domestic market with a lower import share of final output than for goods. This provides companies with more direct control over their operations, pricing and supply chain and appears to be important in driving stronger market performance.

By contrast, UK manufacturing has declined domestically for two or more decades. EY research shows that the UK has off-shored a greater share of its manufacturing capability than the USA, Germany and France since 1995. UK manufacturers today import around 60% of the final value of their products compared to US manufacturers who import around half this proportion.

We also found that UK manufacturers have tended to contract out their off-shored manufacturing rather than either build or buy facilities in other countries. Between 2010 and 2014 for example, German companies invested on average in 165 manufacturing and 54 logistics projects a year compared in the rest of Europe to 29 and 10 respectively from the UK.

German companies have taken a different approach to offshoring than their UK counterparts and this has allowed them to retain more control – greater agility – over their extended value chain

…partly because this is what Government policy has supported…

The UK services sector is competitive on a world stage and this reflects the strength of the UK domestic industry. However, it is also true that UK Government policy has favoured the services sector. Regulation has been light and the focus on lowering the rate of corporation tax rather than either increasing capital allowances or reforming business rates has favoured services over goods. Even more significantly, a failure to invest sufficiently in infrastructure, skills and R&D and constantly changing energy policies have all contributed to the declining competitiveness of the UK goods sector.

In addition, the focus on recent years by the UK in driving exports to the BRICs has been of little benefit to the goods sector. EY ITEM Club research shows that export success depends on having the right product and market portfolio. It was incredibly optimistic to think that after years of neglect of UK manufacturing, it would be possible to penetrate successfully new markets which were demanding goods that the UK doesn’t make. There has to be more rigorous analysis of capability to compete rather than a top down identification of relative market growth rates. The UK’s relatively slow growth in the BRICs is no surprise.

…and change will require more collaboration between the public and private sectors.

There is a great deal to do if the UK is to break the trend of consistent decline in our world market share for trade in goods. But the change in the world economy means that there is currently a unique opportunity to change the UK’s performance in goods. Modern manufacturing is increasingly reliant on technology rather than labour costs and the UK’s experience with services shows that we can be competitive and successful in such environments.

If the UK is serious about improving its performance as an exporter of goods then we must develop an integrated trade strategy that clearly defines the roles of: exports; attracting FDI; supporting Overseas Direct Investment by UK businesses; and import substitution activity. This should also set out Government’s role as the orchestrator of activity bringing public and private sector resources together.

A sector and product focus is required with an explicit industrial framework identifying the work required to build the capability to support highest value trade sectors.  In particular the role of technology and the potential to rebuild a manufacturing base to enable the UK to compete in the market for industrial products should be defined in detail. A more ambitious strategy for Reshoring should be a key element of this approach.

The approach must also include a realistic plan for developing key supply chain capabilities in key sectors identifying the resources, skills, infrastructure and research investment required to build these. Alongside this is the need to identify the investment in infrastructure that will drive real and sustainable differences in export performance.

What does the transfer window mean for this Premier League season: The empire strikes back?

Football is back…

After the international break, the Premier League is back. I start every season with the same hope: that Stoke City will not be relegated. Any other outcome is a bonus. In recent years the fact the club has been in the Premier League has reduced my concern somewhat, I was more nervous when we were in what is now League 1 as the trapdoor to non-league football was, in my world, only a couple of bad seasons away.

The start to the season has done little to allay my fears, although I believe we must have used up our share of bad refereeing decisions already, but the competition starts again with the transfer window now closed. It feels to me as though Stoke City had a good transfer window and I am looking forward to seeing our new players play at home to Tottenham Hotspur tomorrow – hoping Wilfred Bony will establish himself as a Stoke City centre forward to rank alongside John Ritchie and Freddie Steele. But this set me thinking, what can we glean from the transfer window about the likely nature of the season ahead especially in the context of my previous blogs on the changing competitiveness of the Premier League?

…after a truly spectacular transfer window…

The transfer window was truly spectacular: around £1.2 billion was spent by Premier League clubs, a new world transfer fee record was set by Manchester United in signing Paul Pogba and 13 clubs broke their transfer fee records, including Tottenham Hotspur late into the deadline day evening. Total spend is hard to be definitive about but this window has seen gross spend around 50% higher than last year and almost double the spend in 2013, only 3 years ago. (I have sourced my data from The Times newspaper on the 1st and 2nd September).

…with behaviour driven by more than extra revenue…

The new television deal has provided clubs with more money to spend and this was undoubtedly a factor in encouraging so many clubs to break their transfer records. But this is not the only factor at play. To understand the drivers we need to look at spending in more detail to understand the motives of individual and groups of clubs.

…as the Empire strikes back…

Although the overall value of money spent in the transfer window was spectacular, the big story was the activity of the “big” 4 (Arsenal, Chelsea and the two Manchester clubs) and the “big” 6 teams (adding Tottenham Hotspur and Liverpool). With apologies to Leicester City, these groups have dominated the Premier League in recent years.

Last season was clearly a shock to the system and the response appears to be one of making sure that there will be no repeat with the 4 teams accounting for 45% of gross spend (43% of net) and the 6 for 57% (55%).  Manchester United were £10 million shy of their highest net spend in the last 5 years and the rest of the “big” 4 all exceeded their highest figure in that period, Arsenal by more than two times.

And the money has been spent on quality. I have previously written about the distribution of “elite” players,  playing for the top 10 FIFA ranked countries plus England and Wales, and how shifts in the mix help to explain why the Premier League has become more competitive in recent years. This window saw the reversal of the recent trends toward a more even distribution of elite players:

  • The “big” 4  increased their share of elite players from 32.5% last year to 39.2%, only just behind their 6 year high of 41%;
  • The “big” 6 share has gone from 50.6% last year to 54.1% this year;
  • The share per club across the rest of the competition is more evenly balanced than in recent seasons with the exception of Everton which has moved ahead of the pack after a strong transfer window.

It does appear that the wealthiest clubs have really pulled the stops out in this transfer window: the impact of Leicester’s remarkable season last year continues to reverberate around the Premier League.

…in a challenging market.

Unsurprisingly given the spending figures quoted above, the 2016 transfer window was one in which the average spend per player went over £8 million. This is close to a 60% increase on 2015 and more than double the 33.5 million average in 2011. With wealthy teams chasing elite players an increase in the price paid was almost inevitable.

But the increase in the average price paid may not just reflect the increased resources of Premier League clubs and the desire of the richest teams to increase their competitiveness – there are signs that the supply of talent may be reaching its limits. There were around 150 transfers in during this window, around 10% down on the last two summer windows.

The sense I had watching Sky TV’s deadline day coverage was that clubs were keen to spend more but there was a shortage of available talent. This is borne out by the numbers of elite players. On my definition, there will be 168 of them in the competition this season, a very similar number to in recent seasons, but more concentrated in the richer clubs. It does seem that there are only so many players to buy of the requisite quality and increased resources can only go so far in attracting new players. With a new television deal in Germany it may well be that competition will become even fiercer in future windows and spending records may tumble again.

And what of the season ahead?

As we all now know from the EU referendum campaign, forecasts by economists are of no value. So you should treat the next section with great care; an economist trying to forecast football…please!

Nevertheless, recognising my limitations, the outcome of the transfer window does suggest to me that the most likely consequence for the season ahead is the return to dominance of the richer teams. For the first time in a while, extra resources have been used to strengthen their playing squads relative to the rest of the competition. We might therefore expect to see more predictability at the top of the classification. By contrast, definitely not what I want to see given my introductory remarks, we should expect even more competition between the rest of the teams and hence a very unpredictable outcome – I predict this season is not for the faint of heart. Watch out for Everton with a new manager and stronger squad.

But don’t forget Leicester City. Last season lingers in the memory and the club appears to have its own way of doing things. Most interestingly, the transfer window dealings and their retention of Riyad Mahrez means they have a unique set of attacking players in Mahrez, Musa and Slimani from outside of the world’s top 10 country teams to complement Jamie Vardy. Will we be sitting back a year from now to discuss how Leicester City’s retention of the Premier League title was built on the innovative and ground breaking transfer strategy of finding value away from the crowd?

 

Should we focus on providing young people with “experience of work” not “work experience”?

The UK labour market is challenging for young people…

The recent report from EY, in association with the EY Foundation clearly set out the challenges young people in the UK face in gaining entry to the workforce. It is true that the level of youth unemployment in the UK compares relatively well to that in most other countries in Europe. Yes the UK youth unemployment rate is almost double that in Germany and above that the Netherlands, but it is significantly lower than the rates seen in France, Italy and Spain. Furthermore, since 2011 – a year that saw unemployment peak in most European countries – levels of youth unemployment in the UK have recorded one of the biggest falls anywhere in Europe.

figure-1-003

It is nevertheless the case that the UK unemployment rate for people aged 16-to-24 is relatively high compared to other age groups.

updated-fig-3 

…but there is no lack of ambition and drive…

This research and the engagement I have with young people leaves me in no doubt that young people are fully aware of the challenges the labour market poses and are keen to do what they can to improve their prospects. In this context, experiences of work are highly valued. They can provide confidence and a sense of achievement. Young people tell us that they would like more opportunities to meet employers, to learn more from them, and to understand the workplace and what their own place in it might be.

…and demand should not be a problem…

The demand for skills is rising fast. As many as 91% of employers face recruitment problems today[1] – while the number of businesses “not confident” that there will be enough people available in the future to fill high-skilled jobs has reached an all-time high of 69% by one count.[2] Demand for key skills is only set to grow – notwithstanding poor growth projections for the UK economy in the wake of the EU referendum. In the management profession alone, the UK is forecast to need 1.9m new managers by 2024.[3]

There is a direct correlation between employer interactions with young people while they are still in school and their prospects. According to the Education and Employers Taskforce,[4] the number of contacts with an employer such as careers talks or work experience that a young person gets in school (between the ages of 14 and 19) can increase their confidence to achieve career goals, reduce their the likelihood of becoming NEET (Not in Education, Employment, or Training) (at 19-24) and improve their salaried earnings. This clearly points towards the tangible actions that employers can take to improve their chances of recruiting a more highly skilled workforce.

…so what is going on?

Young people want to work and employers need skills. Why are supply and demand not meeting as effectively as they could? I continue to be surprised and excited by the large number of employers across the country doing great things for young people and offering inspiring experiences of work. I also know that many schools do an excellent job in creating these opportunities for their students.

In order to understand the situation in more detail, the EY Foundation and the CMI commissioned a survey of 1,510 16 to 21 year olds from across the UK about their views and experiences of work. The results provide fresh insights and pragmatic suggestions to help strengthen the connections between schools and the workplace. The EYF and CMI report provides detailed analysis and recommendations on a range of areas, I focus solely on work experience in this blog but the report covers a broader scope of issues.

Work experience isn’t working…

Young people need more experiences of work and chances to develop key skills.

  • While most young people have had some experience of work, 56% think it’s difficult to get the sort of experience needed to get a job they want. 88% call on employers to offer more work experience.
  • It appears that work experience through schools is becoming rarer, having been made non-compulsory – only 51% of 16 to 18 year olds say their school offers work experience, compared to 64% of those now aged 19-21. This may jeopardise the opportunities available to those from disadvantaged backgrounds.

The career choices that young people make are being influenced by parents and teachers, who are imperfect sources of information.

  • Parents/carers are by far the most common sources of advice on jobs and careers, with employers much less prominent: only 56% of young people say that employers have come into their school to talk about opportunities.

 A lack of knowledge about the jobs market risks undermining young people’s ambitions. This is worse for some regions or for young people from poorer backgrounds.

  • One in three don’t feel confident about getting a job in the next couple of years.
  • Young people from lower socioeconomic groups are considerably more likely than their peers to lack confidence in getting a job locally (33% compared to 25%).
  • 35% of young people do not know about employers and jobs in their local area and, perhaps as a result, 31% don’t think they can find a job (or a new job) in the area they live.

…and is often not a great experience…

There are areas where the quality of work experience can clearly be improved upon. 56% of young people say they weren’t given training while on work experience, 49% weren’t told what skills they would need to the get a job in the organisation, and 25% didn’t even receive feedback on how they performed. Only 14% of young people who have done work experience were offered a job at the end.

…but young people value their experiences of work and recognise the benefits

  • The majority of young people are positive about work experience and the benefits to them. This includes improved confidence (65%), improved teamwork and communications skills (63%), and a sense of achievement (61%).
  • 88% of young people say that employers need to offer more work experience – not least because they recognise that it is important to employers when it comes to recruitment (also 88%).

…and say that work experience helps them know what skills employers are after ..

Young people recognise the emphasis that employers place on practical skills, rather than just qualifications. They consider organisational skills (68%) and communication skills (65%) as very important to employers, compared to only 35% who say exam results are very important.

…but they need better work experience as they aren’t always confident in their abilities

However, young people are not very confident in their communication and leadership skills. Only 25% think they are very good at communicating what they think or taking initiative. Even fewer say they are very good at talking in front of a group of people (15%) or getting people to work together (14%). Young people from lower socio-economic backgrounds are even less likely than their peers to think they are good at talking in front of a group of people (38% vs 50%), or motivating other people (47% vs 54%).

Time for a new approach to work experience…

In order to improve the transition from school to the workplace, it is clear that young people need the right information and the right experiences to make the right choices about their future. Young people shouldn’t have to get lucky when it comes to getting access to good opportunities.

We need greater levels of collaboration between educators, parents/carers, government and employers, working in joined-up ways across the regions to create change that benefits young people, employers and the UK economy in terms of their skills agenda.

…which provides a real “experience of work” whatever form it takes.

We should be less concerned about sending young people off to a place of work for a week and much more concerned with ensuring that young people learn more about the world of work every year from 11-18 as part of a new school-to-work curriculum. The challenge is for employers and educators to transform the way that they engage with each other, so that every young person, in every school and college across the UK is able to benefit from a true experience of work. This will build on the huge amounts of activity already in place but with the aim of creating an overall framework and clear expectations as to what young people can expect over their school career in terms of their experience of work.

These experiences of work could mean employer-speaking programmes in schools, workplace visits, or mentoring schemes that increase in duration over time, and lead up to extended work placements in the final years of school. Fundamental to this approach is to consolidate the excellent work done by many schools and employers now, which can be ad hoc or location-dependent, and instead create a national high-quality curriculum of learning and experiences of work, locally delivered, over every young person’s school career.

This new school-to-work curriculum will require leadership from government and employer bodies, and closer collaboration between schools and employers to deliver it. It’s also vital to involve parents/carers who are significant influences on young people’s experiences and choices, but often need support to understand all the opportunities that are available to their children, which extend beyond their own experiences of the workplace.

By its nature, work experience for young people will normally be delivered locally and it seems likely that a key part of matching skills to opportunities is a good awareness of local and regional economies. With the devolution of more and more decisions over economic policy to cities and regions in the UK, it is logical to seek to include experience of work programmes under this umbrella.

[1] National Management Salary Survey 2016, XpertHR/CMI, May 2016

[2] CBI/Pearson Education and Skills Survey (July 2016)

[3] UKCES Working Futures 2014-2024, April 2016

[4] It’s Who You Meet: why employer contacts at school make a difference to the employment prospects of young adults, Dr Anthony Mann, Director of Research and Policy, Education and Employers Taskforce (February 2012)

Capital allocation post Brexit: Into the unknown

A blog by Mark Gregory and Michel Driessen, Partner & Markets Leader, Transaction Advisory Services, EY

There is no precedent to guide capital allocation post Brexit, so don’t rely on the standard macro response, look beneath the surface for the long-term opportunity.

Brexit is unique…

There is no previous event for us to compare Brexit to. No developed country has chosen to inflict a shock of the nature of Brexit on itself.  While there is currently a great deal of noise about what the UK can and can’t do and what the impact of Brexit might be, the reality is that no-one can be sure.

…so don’t rely on the markets’ reaction…

The financial markets appear to have stabilised after the initial shock of the referendum result. But don’t be fooled. There is currently very little post-vote information on which to develop an accurate view of the future. The markets are guessing just like everyone else.  As we saw, after stabilising post-vote, sterling soon came under pressure when the first release of PMI data after the referendum painted a negative picture.

It will be the end of the summer before we have sufficient economic and financial data to develop a clear view on the state of the economy and our prospects. Now is as good a time to have a holiday, sudden decisions based on little information are as likely to destroy value as they are to create it.

…as their initial response was not very sophisticated…

The early market reaction was exactly what we would expect: a traditional response to a forecast economic slowdown:

  • Sectors and companies reliant on domestic growth were marked down;
  • By contrast, companies with exposure to export markets, especially emerging markets, were seen as benefitting from the falling pound;
  • Large cap stocks were favoured relative to smaller companies.

Chart 1

Chart 2

Things have moved a little as shown below but the market continues to favour defensive sectors and companies likely to benefit from a lower exchange rate. There has been some adjustment as demonstrated with the relative repositioning of healthcare and telecoms, possibly reflecting the potential risks of lower migration on staffing from the former and possible regulatory pressure on the latter. Deeper analysis is still required.

Chart 3

…failing to reflect the specifics of Brexit…

At first sight this appears rational, it is certainly conventional. However, Brexit could well be different as the changes in trade, migration and regulation that will come as a result will impact sectors in different ways and these may not be the same as the traditional impact that results from a general economic slowdown.

… And other potential major shifts in policy.

Brexit is a political rather than economic shock and the political shock may turn out to be more significant for capital allocation than Brexit itself. The change in UK Government policy post the referendum vote may turn out to be at least as dramatic as the move to leave the EU, if not more so.

Reflecting on the nature of the vote, the new Prime Minister has signalled her intention to make the UK economy work for everyone. In so doing, she explicitly acknowledged that more intervention in the economy than has been the case in recent years may be needed to achieve this. The new Chancellor of the Exchequer has also indicated that he would be willing to adjust the UK’s fiscal strategy to support the economy if required, another significant departure from the past.

It is possible therefore that fiscal policy will be able to mitigate other forces that are slowing UK growth. While a more ambitious industrial policy will stimulate growth in selected sectors and regions. Brexit may be an economic shock but Government policy may mitigate this and help the UK adjust more effectively to a changing world. The key implications for investment are:

  • Government spending and intervention may have a differential impact on sectors; and
  • It is not yet clear there will be a full scale economic slowdown, consumer spending may hold up better than business investment anyway, especially if public spending mitigates any slowdown in business investment.

…and Brexit is not the only change in the global economy…

The UK leaving the EU is not the only source of change and uncertainty in the world today:

  • Overall global growth has slowed driven by a significant slowdown in the emerging markets;
  • China is embarking on a major reshaping of its economy and its growth has slowed, although it remains relatively high;
  • The BRICs are no more, Russia and Brazil are both facing difficult economic conditions but India is growing strongly;
  • Capital has started to move back to the developed world as investors rebalance their portfolios.
  • The UK referendum result is just one example of an increasing challenge to globalisation and its perceived consequences.
  • Digital technology is increasingly being used to disrupt traditional business models

Focus on the future.

The future opportunities for UK based businesses will be determined by the interplay between the Brexit negotiations, Government policy and the UK economy against a backdrop of change in the global environment. A traditional macro view of M&A based on the key macro drivers alone and failing to take policy shifts into account may provide the wrong guidance.

Key investment themes

There are a number of themes for investors to explore in this complex UK landscape:

  • Infrastructure: existing assets may benefit from higher inflation which will support increased end user charges under price cap regimes, as well as lower financing costs. There is, however, a risk of higher staff costs if immigration controls restrict labour supply.
  • Government & new infrastructure: In an era of low inflation and relatively cheap finance, if the public sector does become more interventionist and commissions new projects and infrastructure schemes, there could be significant opportunity. A new runway in the South East, more road and rail schemes are possible and offer investment potential. Businesses with a presence in the sectors supplying these infrastructure projects could offer interesting opportunities.
  • Longer term exports: Global growth is slower than in the past but the recovery in the USA remains robust and India and China are both posting healthy GDP growth figures relative to other countries. It is likely that the UK will be able to secure trade deals with at least some of these countries on leaving the EU and hence the potential trade benefits go beyond the short-run gain from a fall in sterling already factored in to market valuations – there is potential upside. Now might be the time to consider acquisitions or joint ventures to create or increase exposure to these export markets ready for life after Brexit.
  • Industrial policy: The UK Government has indicated it will be pursuing a more active industrial policy. That policy is likely to favour capital intensive, knowledge based sectors that have the potential to use technology to enhance the UK’s competitiveness relative to labour intensive countries. Sectors that offer the potential to create employment opportunities outside of London could find public support is available because of the desire to rebalance economic activity geographically. Our regional economic analysis has identified Electronic and Optical products, Motor Vehicles, Machinery, Clothes, Paper and possibly Food as sectors which could provide the best regional growth opportunities.
  • Industrial supply chain: With the new lower level of the pound likely to be the norm for a significant period of time, favourable financing, and additional support, such as incentives or changes to business rates, reshoring and import substitution could become attractive propositions. If this can be allied to export growth to new markets there could be a win-win for certain sectors. Our previous work on Reshoring suggests Electronic and Optical products, Aerospace, Paints and Varnishes, Pharmaceuticals, Chemicals, Motor Vehicles and Paper were all interesting sectors worthy of consideration.
  • Digital enabler: Digital is not a new theme but there is potential for a new focus post-Brexit. If policy does move to a greater focus on industrial development then digital technology will become very important as an enabler. While there is a major focus on “the internet of things”, digital businesses that offer the potential to transform industrial processes and help address potential labour shortages if immigration is reduced would be potentially very attractive.
  • The new consumer: The outlook for consumers is uncertain. Some of the early post-referendum confidence data suggested a slowdown in consumer spending is imminent. On the other hand, Ipsos Mori reported that consumers were less negative about the short-term impact of Brexit and more positive about the long-term than before the referendum. Policy may soften the slowdown in spending, welfare reform appears to have been pushed back and more support may be forthcoming in the Autumn Statement. If the government is able to mitigate the impact of the initial Brexit shock then consumer and retail sector valuations may have fallen too far.

Look to the long-term for Brexit opportunities

Brexit is a major shock and there is significant uncertainty about the immediate outlook for the UK economy. However, the picture is becoming clearer as the new administration finds its feet and senior level meetings with other European leaders take place.  Despite the short-term uncertainty, we can begin to paint a picture of some of the likely long-term developments around trade, industrial policy and other policy initiatives. These do lead to potential opportunities which look different to the short-term market signs. There is clearly risk attached to any long-term strategy but moving now to create future options is worthy of consideration.

Brexit means Brexit…but what does Brexit mean for the TMT sector?

The markets were gentle on TMT (Technology, Media and Telecommunications) in the immediate post-referendum adjustment.

The immediate market reaction in the first week after the referendum on the UK’s membership of the EU led to little change in TMT stocks. This suggests the view was that the TMT sectors were neither significantly exposed to a domestic slowdown nor likely to benefit from higher exports to emerging markets as a result of the falling pound.

Chart1

Four weeks on and the story has not changed significantly. The Technology and Media sectors have strengthened slightly and Telecoms has slipped a little but all are very minor moves. The impression is that it appears the general view is that the TMT sectors are not overly exposed to the risks of Brexit.

Chart 2

We need to look longer-term to understand the true potential impact.

Brexit is unique: no developed economy has imposed a shock on itself of this potential scale. Brexit is a political rather than an economic shock and as such the long-term impact will depend on the interplay of political and economic factors. Three areas will be critical in shaping the long-term outcome:

  • The development of the UK economy over the next few years as the country moves towards Brexit;
  • The negotiations between the UK and the EU, and between the UK and other countries, which together will shape the future international relations of the UK; and
  • Government policy to support and develop the UK economy over the next few years.

The economy will be challenging…

The EY ITEM Club Summer 2016 forecast confirms that the domestic economy faces a challenging period going forward. EY ITEM Club is more positive about 2016 but more negative about 2017 than consensus. Broadly speaking, consensus is that aggregate GDP growth for 2016 and 2017 will be about 40% down on the level forecasters expected in the spring.

…but it is too early to call…

On the economy, despite a fall in confidence, consumer spending seems to be under less pressure than business spending. Investment and exports should be stronger supported by a lower pound. The likely developments in the key economic indicators which are most significant for TMT are:

  • Nominal interest rates will be at or close to zero for the next 2 years and real rates will be negative;

Chart 3

 

  • The pound is likely to weaken further and we should assume this lower level will become the norm, the UK’s current account deficit and the shock to trade from leaving the EU are likely to weigh heavily on the currency;

 

Chart 4

  • Inflation will return and could be running at around 2% by the end of the year or in early 2017. This could accelerate if labour market pressures caused by a fall in immigration lead to wage rises.

 

Chart 5

 

Brexit means Brexit…but what does Brexit mean?

Changes in three areas will drive the impact of Brexit on the UK and hence on the TMT businesses in the medium to long-term:

  • Trade policy;
  • Immigration; and
  • Regulation

The appointment of trade ministers has given us a first set of clues as to the future trade strategy. With a clear commitment to reduce immigration by all Ministers who have spoken about it, it seems highly unlikely that the UK could join the EEA. This leads to a future based on a bilateral deal, or a series of, with the EU.

Logic would suggest that a deal on goods should be achievable – the balance of trade between the UK and EU in aggregate and at a country level should make this attractive to most players. Goods trade is also the area easiest to fix in trade deals generally. By contrast, services and especially financial services will be tougher. The UK runs a huge surplus with the EU, averaging more than £10 billion annually in financial services, and it seems likely that EU countries will try to capture some of this activity.

We might see a bilateral deal by 2019 or possibly a default to WTO rules at that time followed by a bilateral deal in future. We can also expect the UK will start unofficial trade talks with the USA and India plus other Commonwealth and Middle East countries, with the aim of having deals in place in 2019 or as soon as possible afterwards. It is possible that the UK as a one country bloc will be able to secure competitive deals with non-EU countries faster than the EU has been able to.

Migration remains the key challenge and we are already hearing anecdotal reports of recruitment challenges and staff unease. The UK’s future labour and skills strategy is the area we know least about currently although it is possibly the most urgent area to resolve.

Regulatory change will be driven in the first instance by the trade negotiations. Other than a few possible head line grabbing moves, most of the action is likely to be post 2019 giving companies a chance to plan and position. The more urgent need is to position for and actively lobby to shape UK Government policy given the signals for change that we have witnessed in recent weeks.

What does this all mean for TMT?

The immediate impact is likely to be via the economy. Business investment may slow and consumer spending too, both of which may impact the customer base of TMT companies. Advertising spend may well be under pressure hitting media companies in particular. The weaker pound may benefit exports but the UK’s imports of technology equipment both phones and devices for consumers and technology for businesses and networks will become more expensive – margins may come under pressure.

Longer-term, the signs that the UK Government will be more interventionist may mean that the regulatory regime is subject to change. Broadband provision and mobile coverage tend to come and go on the political radar, it is possible that they will be very much back in the spotlight. On the other hand, the desire to use public spending to invest in productivity enhancing technologies could create opportunities for TMT companies. Schemes which boost economic potential and create opportunities in regions outside of London may well be eligible for public support via grants, tax incentives or investment funding.

The labour market, especially for skilled staff could be challenging if the UK moves to restrict immigration. At the same time, the development of skills and improving educational attainment is likely to be a priority and TMT sector companies should consider how they can contribute to this aim.

Phew, that was the week that was!

Retail was in the immediate post-Brexit firing line…

The immediate stock market reaction to the result of the referendum on the UK’s membership of the EU saw retail stocks heavily marked down. This was consistent with the treatment of sectors deemed to be most exposed to a domestic slowdown such as housing and the banks. By contrast, sectors with more exposure to exports to emerging markets, such as Life Sciences and certain sub-sectors of Consumer Goods fared well, boosted by the falling pound.

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…and the outlook appears challenging…

The EY ITEM Club summer forecast confirms that the domestic economy faces a challenging period going forward. EY ITEM Club is more positive about 2016 but more negative about 2017 than consensus. Broadly speaking, consensus is that aggregate GDP growth for 2016 and 2017 will be about 40% down on the level forecasters expected in the spring.

In addition, although the economic activity was slower and the Bank of England chose to hold off on any loosening of monetary policy last week, the members of the MPC have signalled a significant monetary boost is likely to be announced at their August meeting. This is likely to add to the challenges facing sterling.

…but it is too early to call…

On the economy, despite a fall in confidence, consumer spending seems to be under less pressure than business spending and investment. Retail sales have slowed but the impact so far seems less than in sectors such as to commercial property, recruitment and business investment which anecdotally appear softer. Moreover, Ipsos MORI ‘s latest survey suggests that compared to before the vote, consumers are more optimistic about Brexit having a positive impact on the economy over the long-term and less pessimistic about the short-term hit. As well as these positive nuggets, retailers with an export business should be evaluating the potential opportunity to boost overseas sales as a result of a falling pound.

…although the key parameters of the outlook are becoming clearer…

The likely developments in the key economic indicators are:

  • Nominal interest rates will be at or close to zero for the next two years and real rates will be negative;
  • The pound is likely to weaken further and we should assume this lower level will become the norm, the UK’s current account deficit and the shock to trade from leaving the EU are likely to weigh heavily on the currency;
  • Inflation will return and could be running at around 2% by the end of the year or in early 2017. This could accelerate if labour market pressures caused by a fall in immigration lead to wage rises.

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Against this backdrop, the potential risks to consumer spending are becoming clearer. Employment growth is likely to slow as employers react to increased uncertainty and the housing market is forecast to go through a difficult period with a knock on effect on consumer spending plans.

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Retailers will need to be agile, monitoring the market and their own customer data and ready to respond to both threats and opportunities. If domestic demand slows, could a shift of focus to export markets help to minimise the potential impact? At what point will falling import prices mean supply chain reconfiguration makes sense?

Brexit means Brexit…but what does Brexit mean?

Changes in three areas will drive the impact of Brexit on the UK and hence on retail business in the medium to long-term:

  • Trade policy;
  • Immigration; and
  • Regulation.

The appointment of trade ministers has given us a first set of clues as to future trade strategy. With a clear commitment to reduce immigration by all the Ministers who have spoken about it, it seems highly unlikely that the UK could join the EEA. This leads to a future based on a bilateral deal, or a series of, with the EU.

Logic would suggest that a deal on goods should be achievable – the balance of trade between the UK and EU in aggregate and at a country level should make this attractive to most players. Goods trade is also the area easiest to fix in trade deals generally. By contrast, services and especially financial services will be tougher. The UK runs a huge surplus with the EU, averaging more than £10 bn annually in FS, and it seems likely that EU countries will try to capture some of this activity.

We might see a bilateral deal by 2019 or possibly a default to WTO rules at that time followed by a bilateral deal in future. We can also expect the UK will start unofficial trade talks with the USA and India plus other Commonwealth and Middle East countries, with the aim of having deals in place in 2019 or as soon as possible afterwards. It is quite possible the UK as a one country bloc will be able to secure competitive deals with non-EU countries faster than the EU has been able to. There is the issue of a lack of trade negotiators but this may be a bonus it is possible to argue a new approach to trade negotiations might benefit everyone.

Migration remains the key challenge and we are already hearing anecdotal reports of recruitment challenges and staff unease. The UK’s future labour and skills strategy is the area we know least about currently although it is possibly the most urgent area to resolve. As the UK has signalled it wants to restrict migration, it may well be the first area in which decisions are announced, particularly given the urgent need to make both UK and EU nationals aware of their future rights.

Regulatory change will be driven in the first instance by the trade negotiations. Other than a few possible head line grabbing moves, most of the action is likely to be post 2019 giving companies a chance to plan and position. The more urgent need is to position for and actively lobby to shape UK Government policy given the signals for change that we have witnessed in recent weeks.

You thought Brexit was a big change

The pace of change in politics accelerated unexpectedly in the last 10 days and we now have more insight into the UK’s preferred policy direction. The early statements from the new Prime Minister and her senior team suggest that the future direction of UK Government policy may be an even more significant change than the act of the UK leaving the EU. In particular, the signs are that economic policy will be significantly more interventionist and that the previous government’s fiscal framework has been abandoned.

These changes will become clearer in the next few months especially with the Autumn Statement which will set out spending plans in detail. The issues of relevance for retailers are likely to include:

  • Infrastructure investments in rail, road, airports, ports, energy, housing, potentially with favourable Government support especially after the UK is free of EU state aid rules in 2019;
  • Spend and investment in the UK regions outside London is likely to appeal to a government keen to position prior to a 2020 election;
  • A strategy for skills and education to support greater inclusiveness will be essential;
  • Intervention in targeted areas such as executive pay, minimum pay etc.

Not as uncertain as we feared

The post-referendum debate has centred on uncertainty and of course there are huge issues still to address but we have moved forward in the last couple of weeks. For retailers, the risk and extent of a consumer slowdown is still hard to gauge but exports offer some potential respite for some parts of the market.

As well as tracking the economy it will be important to follow the Brexit negotiations and see how changes in the UK’s relationship with the EU will impact the sector. Labour market conditions could change quickly but longer term shifts in trade and policy may have the greatest impact on the shape of future portfolios and the design of business s models.

Can Brexit be the catalyst for UK economic reform?

An uncertain outlook….

The EY ITEM Club Summer forecast sets out how challenging and uncertain the economic outlook is with a significant downgrade in expected GDP growth compared to April’s forecast. Given the likely shock to the economy from the decision by the people of the UK to leave the European Union, this change in outlook is unsurprising.

Business investment and GDP

However, all the current forecasts are highly uncertain – we arguably know no more, and possibly less, than we did before the referendum. The result is clear but the UK political landscape is being rebuilt after an earthquake and discussions with the other members of the European Union have not yet started.

…unlikely to change soon…

Businesses should organise their planning and analysis in this uncertain environment around 3 time periods:

  • The short-term, probably until after the Autumn Statement, when we will have more clarity on UK Government policy and sufficient post-referendum economic and corporate data to enable us to develop a clearer view on the likely future path of the economy;
  • The negotiation period: two years seems a sensible working assumption for the process. The hope is that the options will be narrowed down as time progresses and hence uncertainty will be reduced; and
  • The longer-term: post exit when the UK will be pursuing its individual economic course. It is of course possible that a new trade deal may take longer than 2 years but the longer-term should nevertheless be significantly clearer in 2 years than it is today.

…so take the time to prepare.

In the short-term, businesses should avoid knee-jerk reactions. Absent good data, decisions made in this period are as likely to be good as they are bad. The focus should be on shoring up the business and initiating the research and analysis to enable strategic and operational decisions as we learn more.

There are obvious challenges moving forward: the EY ITEM Club expects both business investment and consumer spending to slow for the rest of 2016 and companies will need to adjust to this.

Real household income and spending

However, there will also be opportunities, especially for exporters, as the pound is likely to remain low for some time. Moreover, as the UK develops its new trade strategy, new markets may open up and existing markets could become more attractive under improved trading arrangements.

Contributions to GDP growth

Monitoring developments will be critical…

The move from the current arrangements to the long-term post-EU position will be driven by four factors:

  • Agreement on arrangements for post-Brexit, UK-EU and UK-rest of the world trade which will impact both exports and imports, the latter critical for many supply chains;
  • Approach to movement of labour between UK and EU and UK and the rest of the world with clear implications for the recruitment and retention of skilled and unskilled workers and also potentially for investment in labour saving technology
  • UK regulation in areas where EU rules no longer apply, offering the scope to “free up” British businesses; and
  • UK Government policy across a range of areas, using the potential freedom from EU “State Aid” rules to forge a new role for the public sector in UK economic activity.

Each of these four areas has clear implications for business but their impacts could vary significantly depending on negotiations. Some effects are likely to be felt sooner than others. Beyond the exchange rate effect already mentioned, shifts in trade are likely to take some time to become clear. But just the potential for changes in the current arrangements for the free movement of labour might start to impact current workforces and upcoming recruitment activity very quickly.

Close attention to the developments in each of these areas in the UK’s exit negotiations will be critical in shaping strategy over the next two years and for the longer-term. Signs of clarity are emerging, the new prime Minister has made clear the approach to the free movement of labour needs to change, and more details in other areas will hopefully emerge in the not too distant future.

…and especially not ignoring opportunity.

Some of the likely opportunities arising from the UK leaving the EU are relatively easy to identify: a reduced regulatory burden and greater trade freedom most obviously. But there are others.

With the likely slowdown in both consumer spending and business investment identified by the EY ITEM Club, the public sector may need to take up some of the slack. The referendum campaign identified concerns over immigration, inequality and geographic differences in economic opportunity amongst others, policy is also likely to evolve to address these concerns.

I expect that there will be a greater focus on infrastructure, education and skills going forward and that this will create business opportunities. It also seems likely that these initiatives will have to be delivered locally meaning an acceleration of the devolution of powers and responsibility to bodies such as the Northern Powerhouse and Midlands Engine.

The outlook is challenging and things may well be rocky in the short-term but the die has been cast and now is the time to begin to shape the future.