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.
…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.
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.
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
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.