Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 02 May 2018 at 12:11 GMT

Credit Impulse Update: The UK is back in the early 1990s – #SaxoStrats

Head of Macro Analysis / Saxo Bank
 Brexit has catapulted the UK back to the unending dreariness of the Thatcher recession.
Photo: Shutterstock

The following is a new monthly publication from Saxo Bank covering the credit impulse. It will be published at the start of every month.

By Christopher Dembik

Prior to the referendum on Britain's membership of the European Union there was a broad consensus that leaving the bloc would harm the UK’s economy. It is too soon to assess the exact economic impact of Brexit since we do not yet know the details of the new relationship between the UK and the EU. However, even before Brexit occurs, the evolution of inflation, wages and credit proves that Britain will pay a very high price for voting to leave the EU. 
The most immediate impact of the Brexit vote was on financial markets. As a benchmark for economic attractiveness and investment, we use data from CBOE Bats that covers 57 indices across 15 countries, pan-European and Eurozone regions, Brexit and sector indices. In the graph below, the blue line represents the 50 companies less exposed in terms of revenue to the UK market (Bats Brexit Low 50) and the red line represents the 50 companies that derive the largest portions of their revenues from the UK (Bats Brexit High 50). 

Since January 1st, 2016, the performance of companies dependent on the UK market is almost close to zero while that of companies least dependent on the UK market is nearly 40%. This gap can be easily explained by higher uncertainty regarding the UK’s relationship with the EU, negative consumer trends and  the decline in the expected future openness of the UK to trade and investment. All of this is making Britain and companies highly dependent on UK less attractive.

The effect of Brexit is also noticeable on inflation, which skyrocketed above 3% from August 2017 to January 2018, before gradually fading as the impact of the depreciation of the pound decreased. However, the financial situation of UK households remains gloomy. In the absence of a rise in nominal wage growth following the referendum, much higher inflation resulted in a loss of purchasing power.

Even in the years preceding the referendum, the rise in wages remained very limited and fuelled behaviours that are reminiscent of those that led to the GFC. Over this period, there has been a boom in consumer credit that resulted in much higher household debt. The UK household debt-to-income ratio has jumped to 133%. This ratio is almost 60% higher than that of the end of the 1980s. Based on historical standards, debt servicing costs are manageable, but, due to the inevitable economic degradation, this will weigh significantly on consumption.

Leading growth indicators confirm this scenario. New car registrations, which are often viewed as a leading indicator of the wider economy in the UK, have been tracking downwards since 2016 driven by falling consumer confidence. The recent increase in consumer confidence, which leads  new car registrations by six months, is far too weak to hope for a lasting reversal of trend.


So far, UK growth emerged less weak than expected mostly due to the positive credit dynamics that prevailed before the referendum. Our in-house indicator credit impulse, which represents the flow of new credit issued by the private sector, reached a historical peak in Q3 2016 at 11% of GDP. This indicator leads the real economy by 9 to 12 months and, as a consequence, it helped mitigate the negative effects of the referendum. Since then, the credit cycle has been completely reversed and our indicator has fallen into contraction, running currently at minus 7.5% of GDP. The magnitude of the contraction is equivalent to that of the early 1990s recession. Though the correlation between credit impulse and some activity indicators is rather poor (correlation with final domestic demand is at 0.52), this sharp negative trend will surely pose some headwind to GDP growth in the medium term.


The negative impact of the referendum on credit is apparent when comparing UK credit impulse with euro area credit impulse. In the space of only two quarters after the referendum, UK credit impulse fell from a highest historical level to negative territory, while credit impulse remained weak but positive in the euro area over the same period.

UK household financial stress (due to higher uncertainty and loss of purchasing power) is well-illustrated by the flow of new personal loans and overdrafts since the referendum. As we can see in the graph below, it has been heading south, running close to zero; ultimately putting an abrupt end to the credit boom that drove the UK economy in the post-crisis years.

Mainstream economists misjudged the short-term resilience of the UK economy but their pessimistic analysis about the UK’s economy remains largely valid in the medium and long term. The combination between a decline in attractiveness, a massive contraction in credit impulse and sluggish consumption pave the way for a lost decade. The main factors leading to economic decline are already in place. Only an unlikely second referendum or major trade concessions granted by the EU to the UK, which are also unlikely, could prevent this from happening.

  — Edited by Clare MacCarthy

Christopher Dembik is head of macro analysis at Saxo Bank


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