This is the longest contraction in UK credit impulse since the early 1990s
Head of Macro Analysis
Summary: Our central scenario remains the extension of Article 50, that should be requested by October 19th, and new Parliamentary elections that could take place five weeks after the initial Brexit deadline.
Our favorite macro gauge UK credit impulse, which explains economic activity nine to twelve months forward with an “R2” of .60, is going through its eighth quarter of contraction, the longest period since the early 1990s. It is currently running at minus 3.9% of GDP versus a low point this cycle at minus 7.2% reached in early 2018. The length of the contraction is similar to that of the period 1990-1992 when the United Kingdom entered into recession due to high interest rates, an overvalued exchange rate and falling house prices.
The current situation is profoundly different since it is Brexit uncertainty that is driving the economic downturn. The uncertainty goes hand in hand with low interest rates, a GBPUSD exchange rate undervalued by 23% and lower house prices in real terms.
The outcome of the ongoing negotiations between the United Kingdom and the European Union is unlikely to change the future of the British economy. The prolonged contraction in the flow of new credit in the economy and the five straight quarters of contraction in business investment are the two key factors usually leading to a recession.
However, there is no guarantee that the UK economy will fall in recession this year as a jump in stockpiling ahead of October 31st could artificially spur economy activity, as was the case in Q1 2019.
Strategic view :
- Our central scenario remains the extension of Article 50, that should be requested by October 19th, and new Parliamentary elections that could take place five weeks after the initial Brexit deadline, ie end of November/beginning of December. At this stage, the polls favor the Conservative Party, but we cannot exclude a wide coalition gathering the Labour Party, the LibDem and the pro-European Scottish.
- The risk of Brexit accident has increased in recent weeks due to Brexit fatigue on the European side but is still unlikely.
- There is still extreme positioning on the GBP. The speculative community remains widely short GBP, though it has slightly compressed since mid-September on the hopes of a new extension. If this scenario is confirmed, it could be immediately followed by a technical rebound of the GBP. However, the long-term view is still gloomy for the British pound as Brexit uncertainty and unsupportive fundamentals (such as the wide current account deficit and negative net FDI flows) remain.
- Based on these assumptions, we expect GBP/USD to re-test for the third time this year the 1.21 level, and EUR/GBP to move back to 0.93.
Latest Market Insights
Q4 Outlook 2022: Winter is coming
- Winter is coming to the financial markets as central banks are tightening their grip. How spring will look is still a question.
European energy crisis: it will get worse before it gets betterThe winter in Europe will be tough, but whether the result is political chaos or sustainable, innovative solutions is still undecided.
A difficult and volatile quarter awaitsAs the year draws to an end, commodities continue to be at centre stage of the world with growth pockets political uncertainty.
The bright side: crises drive innovationThe positive spin on crises is that they come with solutions. It is worrisome that deglobalisation may be a response to this crisis.
Green transformation in China: renewable energy and beyondGoing green, China needs to span numerous energy sources to ensure stability, as every source comes with a challenge.
Asia: Intermittent solutions, but a faster renewable adoption curveAsian energy supply is being squeezed. This and the adoption of renewables may change the investment sentiment in the region.
FX: A Fed thaw needed to deliver a sustained USD turn lowerThe US Dollar can keep momentum when the Federal Reserve continues to tighten, leaving the rest to play to their drum.
Autumn can become ugly for equities and bond holders. Comfort for Dollar longsTechnical analysis suggests that equities could face a tough Q4 as could fixed income. US Dollar positions could provide some upside.
The next stock market sector to watch, with stocks going nuclearAs the world scrambles to find affordable, sustainable energy, nuclear is getting attention from politicians and investors alike.
The crypto space is getting cold when the hype disappearsCryptocurrencies face a winter of their own as retail investors and governments are asking tough questions.