Financial Update from Brewin Dolphin - 3 March 2023
The Weekly Round-up
Friday 3 March 2023
In his latest weekly round-up, Guy Foster, our Chief Strategist, discusses the Northern Ireland Brexit deal and a rebound in services sector activity.
Last week we briefly discussed what was, in the end, the early stages of an attempt by prime minister Rishi Sunak to float a deal on the Northern Ireland protocol. Facing suspicion, division and veiled mutinous threat from his party, the planned announcement was delayed. This week it was finally made on Monday.
The Brexit breakdown
Northern Ireland had become a major challenge for the implementation of Brexit. A border needed to exist between the UK and the EU. The question was whether that would be on the Irish sea, effectively leaving part of the UK in the EU, or between Northern Ireland and the Republic, underlining the divided state of the island, creating unwanted frictions, and risking reigniting the troubles.
One of the tasks of the Northern Ireland protocol was to reconcile these positions, which it did by creating a customs border on the island of Ireland, but with the effects largely felt by goods passing across the Irish Sea.
The arrangement was unpopular with unionists as it made trading relations with Northern Ireland distinct from those of the rest of the UK. The Democratic Unionist Party withdrew its participation in the power sharing executive until such time as Westminster was prepared to implement the Northern Ireland Protocol Bill (which would unilaterally override parts of the protocol itself).
Negotiations aimed at reforming the protocol were acrimonious and unproductive. Opinions differed over whether the right approach was to try to rebuild trust between the UK and the EU, or to utilise the threat of the Northern Ireland Protocol Bill in order to try and force concessions.
Based upon the announcement made at the beginning of this week, it does seem like history will record a win for the more diplomatic approach.
A Berkshire breakthrough?
The so-called Windsor framework achieved much of what the protocol did not. Red and green lanes would be established for goods moving into Northern Ireland from the UK. Those goods destined for the EU would use the red channel and be subjected to checks and paperwork requirements. Goods only passing as far as Northern Ireland could use the green channel. They would be subject to spot checks based upon evidence of non-compliance. The distinctness of the arrangements, a limited role for the European Court of Justice, and the ‘Stormont brake’ (which would prevent the automatic implementation of EU rules within Northern Ireland) mean that the framework does not fully satisfy the DUP. However, as the weekend approaches, there is hope that pragmatism may be able to overcome absolutism.
The direct economic impact of a consensus on the Windsor framework would be modest. Trade between Northern Ireland and Great Britain will be eased, but even with checks and paperwork taking place, Northern Ireland has outperformed the broader UK economy since Brexit came into force. To be fair, that seems to have more to do with it experiencing less of a contraction during the initial lockdown. More importantly, Northern Ireland only represents around 2% of the wider UK economy.
Some business benefits
Regardless of how small the direct impacts of resolving the Northern Ireland protocol are, it does seem likely that it will facilitate progress on other points of contention. Businesses will also feel more confident about investing in the UK if they feel that the country’s trading relationship with the EU is a known quantity. That would be facilitated by an established trading relationship and some kind of conviviality and trust. It is undermined by the threats of unilateral withdrawal from agreements. Business investment has been recovering from its post-Covid slump, but it has yet to exceed the plateau that it maintained since 2016 – a period bedevilled by regulatory uncertainty and political infighting.
If the Windsor framework were agreed, then the UK economy would be beginning this year with political and economic momentum.
An industrial inflection…
The service sector appears to have moved back into expansionary territory during February (last week’s provisional purchasing managers’ index, or PMI, was revised marginally higher). The PMIs showed services sector activity expanded at an accelerating pace across all regions. Currently, 34 out of 36 forecasters compiled by Bloomberg expect a modest recession during the first half of this year, but those forecasts seem destined to be revised. The opening quarter, at least, seems unlikely to see a contraction.
In the US, the Atlanta Fed’s GDP Nowcast suggests the economy will grow at an annualised pace of 2.3%, which is similar to last quarter but higher than any of the 61 forecasters expressing a view on Bloomberg. Jobless claims were lower than expected (as they have been for ten out of the last 12 weeks).
The tone from businesses is quite mixed though. Some are seeing customers pushing their orders back; others say the year has started strongly. The outlook is not universally optimistic by any stretch of the imagination.
For one thing, there is some evidence that cost pressures are resurfacing. Surveys were quite ambiguous on the subject (some hot, others cooling) but provisional inflation data from France, Germany, Spain and the wider eurozone told a consistent tale: prices rose surprisingly fast during February. US consumer confidence was also surprisingly downbeat.
The rebound was most abrupt in China. It is clear that Chineseactivity levels will recover strongly this year, but whether that happens over months, quarters or the full year is less obvious. The unique nature of recovery from Covid lockdowns is complicated by two years of propaganda making Covid out to be worse than it had seemingly become and low confidence in the domestically produced vaccine. Although it is difficult to equate PMIs to a specific rate of activity growth, it seems like the early stages of this recovery will be particularly vigorous. Adding fuel to the recovery is home sales, which grew year-on-year for the first time in 19 months.
The Hang Seng index, however, briefly gave up its gains for the year (it recovered a bit overnight). The economic outlook looks good for China, but over the weekend the National People’s Congress begins and with it comes Xi Jinping’s new leadership team. Opinion is divided on whether these leaders represent an end to the economic reforms that have been the bedrock of the China bull case since the rule of Deng Xiaoping, or whether they are just the kind of experienced Chinese political operatives who can actually make change happen.
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