Can a Post-Brexit British Economy Prosper Under Johnson’s Government?

Europe leaving. Silver brexit coin with british map on the brick wall. Image source: Adrian Black © 123RF.com

Britain finally parted ways with the EU on the 31st of January 2020, and now not even a month afterwards, its economy seems to be doing reasonably well for itself. Inflation is within the target, unemployment remains low, and the general business confidence is at six years high. In one way, Boris Johnson's hard-line stance on Brexit and his unyielding desire to take Britain out of the bloc without any further delays stimulated the economy in one particular way – it accommodated the build-up of momentum.

The Tory party under Theresa May seemed very divided and without a decided course, which is why the PM was ultimately ousted of her office. Under Johnson, in contrast, the conservative government had a single and clearly defined goal – leaving the EU by the agreed date at all costs. Johnson failed to secure a trade deal with Brussels, which raised some concerns in the House of Commons; nevertheless, concessions were made in favour of a definite departure from the EU instead of asking Brussels for another uncertain extension of the Brexit deadline.

Because of this, Johnson's uncompromising leadership was perceived as a breath of fresh air compared to May's erratic time at 10 Downing Street, and the pivotal departure date served as an overdue catharsis for the divided Parliament.

Johnson’s time at the helm of British politics has so far been judged to be mostly successful, which has most prompted reinvigorated investors’ confidence and optimism in the British economy. This feeling of moving past the Brexit ambiguity with the sense of finally having a general direction and a solid course of action, albeit without a secured trade deal, is what is causing all of this excitement amongst traders and investors in the city of London.

The general feeling of enthusiasm can be best quantified in the Business Confidence Index chart below, which illustrates a sudden surge to +23 index points in the first quarter of 2020 from the -44 index points that were recorded in the previous period. This is the best result on record since 2014, which elucidates the across the board optimistic outlook of British investors and businesses in the wake of Britain’s departure from the EU.

Despite these overwhelmingly positive findings, however, other things need to be considered before declaring Brexit a complete success.

Arguably, the most concerning news came in December when it was announced that the British trade surplus jumped to GBP 7.72 billion, which is the biggest one on record. Ever since the measurement of the trade balance began, the UK has never been able to record such a considerable difference between exports and imports.

What is so troubling about such a massive discrepancy between exports and imports, is that Johnson's failure to secure a trade deal with the EU is likely going to result in shortages of important goods and services in the forthcoming weeks and months.

Unless the PM manages to come to terms with his European counterparts swiftly, or alternatively find new markets, the reduced imports are going to stifle growth in the near-term.

The recent businesses enthusiasm in Britain, which is what is currently supporting the industry and offsetting the negative impact of the trade uncertainty, is going to be short-lived unless the government manages to secure a sustainable trade deal with a suitable foreign market.

So far, the government has been attempting to negate the impact of the trade uncertainty by boosting its aggregate spending. The overall government spending has reached GBP 101.5 billion in the fourth fiscal quarter of 2019, which is also the highest number on record.

Expansionary fiscal policy has been proven to be more than efficient at such turbulent times when it is supported by tight monetary policy, which is underpinned by substantial liquidity in the markets. In simpler terms, higher government spending promotes economic growth when the underlying interest rate is low.

Such a strategy, however, might pose problems of its own. The diminished imports of vital goods and services in conjunction with heightened government spending is likely to bolster the inflation rate past the Bank of England’s 2 per cent target rate.

Under normal circumstances, the central bank would tackle soaring prices by lifting its interest rate; however, under the current scenario this seems highly unlikely. Many market experts actually anticipate a reduction in the rate to take place in the following months.

Thus, the multiplier effect is likely to be increased just enough to sustain marginal economic growth in light of the trade uncertainty that continues to weigh down on the British economy. Simultaneously, inflation would continue rising, which would inflate a new debt bubble and a potential ticking bomb.

Said in other words, increased government spending and accommodative monetary policy alone would not be sufficient to promote sustained economic growth in the long-term. Even so, as a consequence of the two policies inflation would continue to rise at a steady pace.

Unless the economic growth matches the rising consumer prices and the two appreciate parallel to each other, the resulting debt bubble would likely have a rippling effect for the economy.

As can be seen from the chart above, the annualized economic growth in the United Kingdom has been steadily depreciating throughout 2019. It has reached a new dip at 1.1 per cent in the last fiscal quarter of that year. To put these results into perspective, the British economy is now nearing marginal growth rates that were last seen after the outbreak of the 2008 credit crunch. Because of that, it can be argued that the economy is very close to entering into a structural recession.

Speculating what would happen with the British economy is difficult at the current time, mostly because there are so many different factors to consider at the same time. It seems though that it enjoys favourable market conditions, and the aforementioned businesses excitement could be used effectively to promote growth in the short-term.

However, it also seems that no sustained growth in the long-term can be achieved without a comprehensive trade deal. In that sense, it can be argued that the UK can thrive and prosper under Johnson’s government, however, the PM would have to act fast and clear away the trade uncertainty by securing a deal, lest the enthusiasm tones down and fear sweeps through the markets once again.