Brexit uncertainty is likely to weigh on UK investment and growth potential - Rabobank

"Speculation about central bank activity is likely to be pushed to the back burner and we would expect UK politics to be the main driver for EUR/GBP heading into the remainder of the year," Rabobank analysts argue.

Key quotes

In his presentation of the November Inflation Report last week, BoE Governor Carney forecast UK GDP growing “modestly over the next few years at rate just above its reduced rate of potential”. This statement was disconcerting for many reasons. The less optimistic outlook for trend growth in the UK refers directly to a prolonged period of low productivity growth in the UK since the financial crisis.  However, the investment growth that could counter this and boost productivity and GDP is, according to the BoE being “affected by uncertainties around Brexit”.

The latest set of BoE forecasts assume that UK consumption growth “remains sluggish in the near-term”. Recent UK economic data is showing that under the weight of falling real wages, consumers are shying away from buying big ticket items such as cars and furniture.   While this is not an environment that is usually associated with a build-up of inflation pressures, the UK economy is still in danger of running into supply constraints due to inadequate investment growth. 

The November Inflation Report states that the economy’s supply capacity is projected to grow “at a relatively modest pace over the forecast period”. As a consequence, “the MPC judges there to be a little less slack at the start of the forecast period than in August, and that is used up by the end”. As a consequence of the impact of political uncertainty on investment, the BoE is thus suggesting that the UK is likely to see both higher inflation potential and lower trend growth than would otherwise be the case. 

Currently UK growth is lagging that of the Eurozone. Sluggish investment growth in the UK suggests that this is likely to persist over the medium-term.  This has negative implications for GBP vs. the EUR.  That said, higher BoE interest rates on the back of a rise in price pressures have the potential to add some support to the pound. 

In the 12 months ahead of the UK’s Brexit referendum in June 2016, the average rate of EUR/GBP was 0.7473. In that period the UK was benefitting from relatively better GDP growth vs. the Eurozone.  While the various Brexit scenarios have different implications on investment, productivity growth and output in the UK, it is our estimate that the UK will suffer a long lasting impact to productivity potential.  The implication is that EUR/GBP will be hard pressed to return to the levels traded at the start of last year. 

Although we are optimistic that an EU/UK trade pact will eventually be agreed, all Brexit proceedings to date suggest that this could be a last minute compromise. In the meantime uncertainty is likely to weigh on UK investment and growth potential.  The implication is that GBP has the potential to slip further on a 12 mth view before snapping back to current levels around March 2019.  We retain a 12 mth forecast of EUR/USD 0.95.