UK and EU: A Tale Of Two Economies

Eurozone is on the up while Britain gets Brexit blues — but each needs the other to thrive.

Contrary to appearances, this is good news for Britain. But it also illustrates what the British economy stands to lose from Brexit.

Some see the contrasting performances of the economies on either side of the Channel — highlighted by the Bank of England cutting its U.K. growth forecast on Thursday — as a sign that worries about Brexit are beginning to weigh on British consumers and businesses.

The economic moods in Britain and the rest of the EU are reflected in their respective political climates.

Brussels is sounding upbeat. A week after the eurozone’s unemployment rate hit its lowest level since February 2009, European Commission President Jean-Claude Juncker said that in the EU these days “there is really nothing to complain about.” Meanwhile, British Cabinet ministers wield economic predictions in their very public battle over whether to pursue a hard or soft Brexit.

Yet for now, British concerns about the U.K. economy are assuaged by the economic vigor of Europe — by far the U.K.’s largest market.

The longer-term problem is that London won’t be able to rely on the same export market once it formally leaves the EU in 2019.

The eurozone economy’s gross domestic product grew 0.6 percent in real terms in the second quarter of the year — versus 0.3 percent for the U.K. Corresponding numbers for the first quarter were 0.5 percent and 0.2 percent, respectively.

“It’s easy to forget that the U.K. economy has relied massively on monetary stimulus in the last year,

The impact of Brexit is manifold. The weakness of sterling is fueling domestic inflation, constraining household spending. Furthermore, uncertainty about the terms of a Brexit deal between London and the EU is putting a brake on investment, as “businesses are delaying crucial decisions,” said Bert Colijn, senior economist at ING Bank in Amsterdam.

Mark Carney, the governor of the Bank of England, noted Thursday as the central bank published its inflation report that Brexit uncertainty “weighs on the decisions of businesses and households and holds down both demand and supply.”

EU helps Britain keep growing

One of the few pieces of good news, said Gilles Moëc, chief European economist at Bank of America Merrill Lynch, came from the U.K. manufacturing sector, whose performance was buoyed by a record growth of export orders. “With the U.S. flat and Asia uncertain, that mostly came from Europe,” Moëc said.

And it seems the U.K. can’t look anywhere else for hope. The Bank of England cut its growth forecast for this year from 1.9 percent to 1.7 percent, after a similar move by the International Monetary Fund last week. (The European Commission’s forecast for the U.K. stands at 1.8 percent). And there are few other available means to boost growth in the short term.

“[The U.K. government] doesn’t have any margin on the fiscal front,” Moëc noted. The U.K.’s budget deficit is forecast at 3 percent of GDP this year, unchanged from last year. That’s more than double that of the eurozone as a whole.

The other source of possible stimulus — monetary policy — has run its course after a massive easing last year in the wake of the Brexit referendum. The Bank of England is currently facing the conundrum of high inflation coupled with sluggish growth, making its policy choice difficult: further monetary easing would fuel inflation, more restrictive policies would hit growth.

The U.K. central bank’s monetary policy committee on Thursday decided to leave its rates unchanged, but two of its members nonetheless voted for a 0.25 percent increase.

“It’s easy to forget that the U.K. economy has relied massively on monetary stimulus in the last year, but that is coming to an end,” Moëc noted.

Continent still fragile

However, a French treasury official who requested anonymity, cautioned that even though “the stars are aligned” for now in Europe, the fundamentals behind the continental economy’s growth remain fragile.

“Spain and Portugal have undertaken a remarkable adjustment, but Italy is still a political risk, Germany’s demographics don’t look good, and reform in France is still more of an idea than a reality,” he noted.

“They need to get their act together fast. The economy won’t pick up until they do,”an official at a major bank in London warned | Daniel Leal-Olivas/AFP via Getty Images

Colijn from ING Bank said that even though the eurozone is growing at a brisk pace — with an overall forecast for next year seen at 1.8 percent — these are “not exceptional rates compared to pre-crisis levels.”

Europe’s population is aging and productivity is declining — meaning “less workers producing less,” he added.

The U.K. economy’s lacklustre performance is marginally hitting its neighbours because the weakness of the pound makes foreign goods more expensive in Britain, hurting European exports to the country.

But only 17 percent of EU exports go to the U.K, whereas the EU absorbs 44 percent of U.K. exports.

The French official noted that only a year ago, “France was the sick man of Europe with demonstrations in the streets, an embattled president and economic and political uncertainty. Now it’s in the U.K. that everything is blocked.”

An official at a major bank in the City of London added that he was worried about the “total fog” created by the government’s hesitations and bumbling on Brexit.

“They need to get their act together fast. The economy won’t pick up until they do,” he warned.