BREXIT: FIRST-TAKE ON THE IMPACT FOR RETAIL

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1 BREXIT: FIRST-TAKE ON THE IMPACT FOR RETAIL Sterling and European stock markets were rocked by the vote for the UK to leave the European Union. On the eve of the result, traders had expected the UK electorate to vote to remain in the EU. In 2017, UK GDP growth is likely to be between 1% and 1.5% lower than it would have been had the vote gone the other way. But major banks do not forecast a recession for the year. In 2017, consumer prices are likely to be pushed up by a weaker pound, but economists are divided on the likely scale of these rises. We expect retail sales volumes to soften due to weaker consumer demand, but the value of retail sales will be supported by raised inflation. We expect this raised inflation to feed primarily into nonfood retail, given the reliance on imports in nonfood categories and given that strong price competition will likely persist in the grocery sector. THE UK VOTES FOR BREXIT On June 23, the UK voted by a 52% majority to leave the European Union on a voter turnout of 72.2%, the highest turnout in a UK national vote since In this flash report, we summarize the immediate impacts of the vote and look at the medium-term economic outlook, with a focus on the impact on the retail sector. This report is being written on the morning of June 24. The vote for the UK to leave the EU hit European stock markets and the British pound hard. The effect was amplified by 1

2 traders who confidently priced in a vote on the day of the referendum. This expected vote was apparently driven by opinion polls that showed a lead for the campaign and the odds on a offered by bookies. At the time of writing, the overriding sentiment is one of uncertainty, and we expect this to continue for some time. This uncertainty is over the timescale of the exit from the EU (or even the formal notification to the EU of the UK s plan to quit) and the nature of that exit. Prime Minister David Cameron will step down by October 2016, with his successor likely to lead the exit. Even after the UK has advised the EU of its intention to leave, it has up to two years in which to negotiate and complete that process. This adds great uncertainty to estimating the outlook for industries. SHORT-TERM IMPACTS All parties expected a vote for to have an immediate impact on the pound and stocks, and we certainly saw that: The British pound initially fell by around 10% against the dollar, but at the time of writing has recovered a little to around 7% down. The FTSE 100 Index initially fell by around 6%, but at the time of writing has recovered some lost ground and is down around 4%. On a one-month basis, however, the index is down by only 1.7%. The FTSE 250 Index initially fell by around 12%. One a one-month basis, the index is down by around 6%. The FTSE 350 Index of General Retailers initially fell by around 12% before recovering, and is down by around 9%. Major UK retailers slumped after the market opened, with discretionarycategory retailers hardest hit: Marks & Spencer was down 19%, Debenhams was down 21%, Next was down 25%, Sports Direct was down 27%, Dixons Carphone was down 30% and WH Smith was down 31%. 2

3 MEDIUM-TERM EFFECTS GDP Growth Set to Weaken But Positive Nobody knows the extent to which will impact economic growth, so economists forecasts for 2017 range from positive but weaker growth, to a recession. Citi forecasts that in 2016 and in each of the years to 2020, there will be a hit to real GDP growth of between 1% and 1.5%. The bank does not, however, forecast a recession on an annual basis, with real economic growth of around 1% in each year. Figure 1.. Citi s Forecast UK Real GDP Growth (%) E 2017E 2018E 2019E 2020E Recreated from a graph provided without absolute numbers. Source: Citi Research ING forecasts GDP growth to slow to 1.5% in 2017, some 1.2% below what they expect it would otherwise have been. In 2018, ING expects this downward pressure on GDP to reduce to around 0.7%. Like Citi, ING does not expect a recession on an annual basis. 3

4 Figure 2. ING s Forecast UK Real GDP Growth (%) E 2017E 2018E 2019E Source: ING The Economist Intelligence Unit (EUI) forecasts a 1% fall in real GDP in This compares to a +2.24% GDP forecast by the IMF prior to the vote. In turn, this implies the EIU expects a swing of more than 3 percentage points in economic growth, which seems unduly negative to us. Consumer Prices Expected to Rise Over the medium term, an expected weaker pound will push up the rate of consumer prices inflation (CPI). However, economists are divided on the scale of these rises. Citi estimates the vote could add around two percentage points to UK CPI in each of 2017 and 2018, and push it up from between 1% and 1.5% to between 3% and 3.5%. The EUI expects consumer prices inflation to be only slightly above the Bank of England s 2% target in both 2017 and ING expects inflation to be pushed up only modestly: in 2017, ING expects inflation in the scenario to be 3.2% versus 3.0% for the scenario. 4

5 Figure 3. ING s Forecast UK CPI Growth (%) E 2017E 2018E 2019E Source: ING Retail Growth Likely to Soften The risk of to retail and other consumer-goods industries comes from two sources: first, uncertainty on the timescale, shape and effects of exit from the EU; second, any deleterious economic impacts of that exit, or from the uncertainty ahead of it. The EUI forecasts real-terms retail sales (i.e., volumes) could fall by around 3% in 2017, compared to +2% in the case of a vote. This compares to a real-terms increase of around 4% in each of 2014 and 2015, and average real-terms growth of 4.4% over the 5

6 first five months of 2016, according to data from the Office for National Statistics (ONS). Given this context, we view the EUI s forecasts as excessively pessimistic: we see little reason for an approximate 7 percentage point swing in retail demand. Our first estimates are that the vote could dent retail sales growth by between 0.7% and 1% in each of 2017 and We show our first estimates for retail sales growth below. We base these on ING s expectations for GDP growth and CPI some elements of which take a conservative view of the effect relative to other forecasts, such as those from Citi. Our figures are for retail sales growth in current prices. Retail volumes are likely to be softened by macroeconomic effects of the exit from the EU. Yet raised inflation is expected to boost the value of retail sales in current-prices terms. Figure 4. UK YoY Retail Sales Growth Estimates Retail Value Growth: Scenario (%) Inflation Impact* (%) Estimated Volume Impact** (%) Retail Value Growth: Scenario (%) E (0.5) E (1.2) E (0.7) 2.4 *The difference between ING s and scenarios for CPI. **We use the difference between ING s and scenarios for real GDP growth as a proxy for the impact on real retail growth. Source: ONS/ING/Fung Global Retail & Technology We expect any inflationary pressures to be weighted toward nonfood retail for two reasons. First, nonfood categories rely much more on imports, which means currency effects are stronger than in food categories; second, we see the ongoing grocery price wars as limiting the potential for solid positive food-price inflation. Figure 5. Positive and Negative Forces in UK Retail Value Growth Weaker pound pushes up shop prices Consumer caukon hits discrekonary-purchase volumes Source: Fung Global Retail & Technology 6

7 Deborah Weinswig, CPA Managing Director Fung Global Retail & Technology New York: Hong Kong: China: John Mercer Senior Analyst HONG KONG: 10th Floor, LiFung Tower 888 Cheung Sha Wan Road, Kowloon Hong Kong Tel: LONDON: Marylebone Road London, NW1 6JQ United Kingdom Tel: 44 (0) NEW YORK: 1359 Broadway, 9 th Floor New York, NY Tel: FBICGROUP.COM 7