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Contraction Over! What Now For The UK Economy?

06/09/2016 11:20 | Updated 06 September 2016

A month after the referendum result, in late July, I wrote a Huffington Post article that the UK economy was contracting, with consumer and business confidence at an all-time low.

It was contracting then. But the more recent data suggests that that may no longer be the case. Monday saw the publication of the Markit/CIPS Services PMI data for August that showed that the confidence of the sector in August had bounced back to 52.9 from July's low of 47.4, where 50 indicates a net positive result. For comparison, August's level is a little higher than June, but lower than May.

The markets responded strongly at this evidence that UK appears to be avoiding an immediate recession following the shock of the referendum result. There was also much reporting of the fact that the month-on-month improvement in the services PMI index was "the largest observed over the 20-year service history" but this reflects more on the unusually low level in July rather than the increase in August. If you take out July's result as reflecting immediate post-referendum panic, then what we see is a relatively steady line over the course of 2016: in positive territory but less optimistic than in recent years. Overall it looks as if GDP growth in the third quarter of the year will be nearer to zero than the dramatic fall than was previously feared.

Taking a slightly longer view, what this says to me is that the uncertainty that began to creep into the markets at the end of 2015 around what the result of the referendum result would be, has been replaced with an uncertainty as to what the decision to leave in the future would mean. So its perfectly plausible that expectations are similar to in the first half of the year, but less optimistic than they were before the referendum was announced.

What we are seeing now is similar to a couple that decide to separate but haven't actually done so yet. The children, initially shocked, continue with their normal routine until the change actually happens. It's there in the background but not in the day-to-day. Similarly, we are now seeing businesses carrying on with their work; in some cases affected by higher import prices as sterling has fallen, others by lower export prices; but since we haven't left the EU nothing fundamental or structural has really changed - yet.

What has changed however is that the UK is now far more susceptible to the concept of political risk - a term normally reserved for more volatile and emerging markets - than it was in the past. Entire markets will find that their future parameters are shaped by the way that politicians explore and present the options over the forthcoming months and years, and that there is little, if anything, they can do about this. But until those options are worked through, there's nothing to be done except to keep on trading.

Back in July I concluded by writing that the data we were seeing at the time "could be no more than proof we were all a bit shaken up by the EU referendum result. The underlying cyclical position of the economy is not bad, and as the months pass we may all decide to go back to business as usual". It looks to me now as if that prediction was broadly correct.

The challenge for the government now is to ensure that as more details come out of the likely policy options, that sense of shock and concern that we saw in July does not return to spook the markets.

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