Business investment already affected by uncertainty?
Business investment, another component of demand, has declined in recent quarters. The peak level of the investment cycle was reached in Q3 2015, at the same time as the uncertainty surrounding the outcome of the referendum has grown strongly.
Despite a recent rebound, the Bank of England’s quarterly survey indicates that companies remain cautious about their investment decisions, in particular those exposed to household demand or trade with the European Union. This wait-and-see behaviour regarding investment decisions is particularly visible for the most irreversible type of investment (for example in infrastructure); by comparison, intangible investment has been less affected, which is characteristic of an uncertainty shock (see the blog Econbrowser).
This decrease directly affects the stock of available capital and could have a significant impact on the country’s growth potential over the next few years.
In conclusion, the effects of Brexit on the UK economy have for the moment been limited. This is probably partly due to a number of factors, such as the decline in sterling or a more buoyant international environment. The policy of the Bank of England, which decided in August 2016 to launch a vast programme of monetary easing (by lowering the key rate to its lowest historical level – i.e. 0.25%, by expanding its bond purchase programme and, among other things, by launching a new corporate bond purchase programme, in a context of fiscal austerity) has also played a role.
As regards short-term growth, it could remain buoyant provided that there is a switch in the growth engines (i.e. net exports taking over from a household consumption which is running out of steam). However, this new situation has no precedent, which generates considerable uncertainty about what lies ahead. While the negative macroeconomic effects of an uncertainty shock, in particular on business investment, are well-known (see, for example, Ferrara et Guérin, 2016), the uncertainty shock associated with Brexit is different from a standard shock insofar as we know that the duration of the shock itself can be extended. Indeed, the Treaties provide for two-year negotiations from the triggering of Article 50, signed on 29 March 2017, but the possibility of a transition period is being widely discussed. Finally, the recent literature shows that an uncertainty shock has strong negative effects when it is associated with a financial shock. Monitoring the developments of financial tensions in the United Kingdom in the coming months will therefore be crucial.