The lyrics of Genesis’ 1986 hit “Land of Confusion” were penned over 30 years ago, with the English rock band satirising Ronald Reagan’s US presidency (see Figure 1). Specifically, they allude to the confusion fuelled by opportunist politicians in a fast-changing world beset by acute challenges. But, in my view, they portray with uncanny accuracy the UK in 2017 as Prime Minister Theresa May and her government, Parliament and the Bank of England feel their way towards Brexit.

1. 1
UK: Land of Hope & Glory…but mostly Confusion
The lyrics of Genesis’ 1986 hit “Land of Confusion” were penned over 30 years ago, with the English rock
band satirising Ronald Reagan’s US presidency (see Figure 1). Specifically, they allude to the confusion
fuelled by opportunist politicians in a fast-changing world beset by acute challenges. But, in my view, they
portray with uncanny accuracy the UK in 2017 as Prime Minister Theresa May and her government,
Parliament and the Bank of England feel their way towards Brexit.
Figure 1: Land of Confusion 1986 could well be UK Land of Confusion 2017
Source: Genesis (Anthony Banks / Michael Rutherford / Phillip Collins)
Land of Confusion, Genesis 1986
I must've dreamed a thousand dreams
Been haunted by a million screams
But i can hear the marching feet
They're moving into the street.
Now did you read the news today
Theysay the danger's gone away
But i can see the fire's still alight
There burning into the night.
There's too many men
Too many people
Making too many problems
And not much love to go round
Can't you see
This is a land of confusion.
This is the world we live in
And these are the hands we're given
Use them and let's start trying
To make it a place worth living in.
Ooh superman where are you now
When everything's gone wrong somehow
The men of steel, the men of power
Are losing control by the hour.
This is the time
This is the place
So we look for the future
But there's not much love to go round
Tell me why, this is a land of confusion.
Land of Confusion, Genesis 1986 (continued)
This is the world we live in
And these are the hands we're given
Use them and let's start trying
To make it a place worth living in.
I remember long ago -
Ooh when the sun was shining
Yes and the stars were bright
All through the night
And the sound of your laughter
As i held you tight
So long ago -
I won't be coming home tonight
My generation will put it right
We're not just making promises
That we know, we'll never keep.
Too many men
There's too many people
Making too many problems
And not much love to go round
Can't you see
This is a land of confusion.
Now this is the world we live in
And these are the hands we're given
Use them and let's start trying
To make it a place worth fighting for.
This is the world we live in
And these are the names we're given
Stand up and let's start showing.

2. 2
At this stage it is important not to mistake confusion with its less corrosive side-kick, uncertainty. As the
saying goes, the only certain things in life are death (and taxes) – as Maynard Keynes reminded us we are
all dead in the long-run. Uncertainty is prevalent in everything from financial markets to the weather.
Financial institutions and corporations strive to quantify uncertainty to improve returns and can reduce
uncertainty, albeit at a cost, using hedging instruments. Uncertainty drives volatility in equities, bonds and
currencies and can thus be indirectly measured using indices such as the CBOE’s VIX.
In the UK, economic and political uncertainty has clearly risen since the outcome of the UK referendum on
EU membership on 23rd
June 2016 and general election on 8th
June 2017 and I would pinpoint the following
ten unknowns as currently the most potent:
1. Will Theresa Mayremain as prime minister until the end of the current parliament?
2. Will the Conservative-DUP alliance, which enjoys a slim working majority of 13 seats in the
House of Commons, successfully pass legislation through parliament?
3. Will this marriage of convenience between the minority Conservative partyand DUP last a full
parliament or could early general elections once again be triggered?
4. Will tax rates be increased to finance greater public spending and/or will the fiscal deficit rise?
5. Will the UK definitelyleave the EU in March 2019 and if yes will the terms and conditions of the
UK’s divorce fromthe EU be favourable?
6. Will the UK have sufficient time to negotiate a new deal with the EU or will it instead opt for a
transitional arrangement?
7. Will a new deal with the EU include membership of the Single Market and/or Customs Union or
some kind of bespoke, hybrid arrangement?
8. Will a new deal with the EU, whether permanent or temporary, be “good” or “bad” for the British
economy in the near and long-term?
9. Is the current slowdown in economic growth and inflation pick-up transitory or self-fulfilling?
10. Will the Bank of England (BoE) Monetary Policy Council (MPC) start hiking its record-low policy
rate, and if so when and how quickly?
However, financial markets are also having to deal with chronic confusion in the UK, which I would argue is
ultimately far harder to measure and hedge against than uncertainty. Confusion feeds and amplifies
uncertainty, effectively making uncertainty even more uncertain. There can be no certainty, however slim, if
there is confusion. For example, one cannot start to quantify the possible impact of tax changes on fiscal
revenues (uncertainty) if the government cannot even agree on whether, when and by how much it will

3. 3
change tax rates in the first place (confusion). Governments rarely run as smoothly as they would like to
portray, but in the UK the confusion is acute, deeply rooted and shows no signs of abating.
While the symptoms of this confusion are rather obvious, as I discuss in Part I, its causes are numerous,
sometimes complex and often self-reinforcing – the subject of Part II. The government, which is in power
but seemingly not in control, is arguably at the epicentre of this confusion. Prime Minister Theresa May and
senior cabinet members do not speak with one voice on key topics such as Brexit and fiscal policy, with
policy-makers clamouring for attention and arguably influence and control. But other economic and political
actors, including Parliament, businesses, industry associations, vested interests and voters are increasingly
voicing their views and adding to the discord and doubts.
Uncertainty makes it difficult to forecast where Sterling will trade next month, let alone next year. But
uncertainty allied to confusion makes it nigh impossible to predict Sterling’s level next week, let alone next
month, or where tax and interest rates will settle. That of course does not preclude attempts to separate the
wheat from the chaff and to make some sense of the baffling contradictions epitomising government
positions – as I do in Part III.
Part I – Brexit and fiscal policy reveal most acute symptoms of confusion
No issue in the past 20 years has divided the UK more than Brexit, in my view, and the cacophony of
opinions is deafening and debilitating. Figure 2 summarises the key players and the spectrum of views and
yet probably still under-represents the granularity of thinking on the issue of the UK’s departure from the
EU. At a government level, cabinet members and the Brexit negotiating team have in the past year been
increasingly prone to expressing differing and sometimes contradictory views about the modalities of the
Brexit process and the ultimate end-goal.
Prime Minister Theresa May, David Davis – the Secretary of State for Exiting the European Union who also
heads up the British Brexit team – Secretary of State Boris Johnson, Chancellor Philip Hammond and
Trade Minister Liam Fox have been unable to agree on the optimal path for the UK in a post-EU world,
putting forward increasingly confused and confusing statements. While Chancellor Hammond wants to
focus on the economic and fiscal impact of Brexit, other cabinet members have prioritised control over EU
immigration while others still have emphasised the over-riding importance of sovereign independence
(including from the European Court of Justice). The government’s opening gambit on the status of EU
nationals living in the UK has raised far more questions than it has provided answers.
Even individual cabinet members’ views are seemingly in constant flux, shifting with the vagaries of popular
sentiment and the realities of the daunting task in hand. Beyond the cabinet, the 318 Conservative MPs’
opinions on Brexit are even more eclectic and widespread, with moderate Brexiters clashing with 30 or so
hardline eurosceptics and a smattering of pro-Europeans (including Kenneth Clarke).

4. 4
Figure 2: Too many chefs spoil the broth
Source: European Commission, European Council, European Parliament., UK government, House of Commons, CBI
Note: * I have listed the most senior positions and those most likely to be directly involved in Brexit negotiations
Cabinet (23 members, all Members of Parliament)*
Damian Green – First Secretary of State, Minister for the Cabinet Office
Philip Hammond – Chancellor of the Exchequer
Amber Rudd – Secretary of State Home Office
Boris Johnson – Secretary of State for Foreign and Commonwealth Affairs
Sir Michael Fallon – Secretary of State for Defence
David Lidington – Lord Chancellor and Secretary of State for Justice
Liam Fox – Minister for International Trade
Greg Clark – Secretary of State for Business, Energy and Industrial Strategy
Theresa May
Prime Minister and Conservative Party leader
British electorate
Leave 52% (17.4mn votes or 37%
of registered voters)
Remain 48% (16.1mn votes or
35% of registered voters)
UK Negotiating Team
Department for Exiting EU (DexEU)
Permanent Secretary – Oliver Robins
Second Permanent Secretary – Philip Rycroft
Director Generals: Alex Ellis, Sarah Healey, Catherine Webb, Matt Baugh,
Chris Jones, Tom Shinner, Joanna Key, Susannah Storey, Antony Phillipson
Permanent Representation to the EU
UK Tim Barrow – Permanent Representative
Katrina Williams - Deputy Permanent Representative
Simon Case – Director General
Treasury
Mark Bowman, Director General, international finance
Home Office
Glyn Williams – Director General
Other
Steve Baker – Junior Brexit Minister
Mark Philip Sedwill – National security adviser to the Prime Minister
Peter Hill – Prime minister’s principal private secretary
David Davis – Secretary of State for Exiting the EU
Conservative Party (318 seats)
Mostly in favour of exiting EU but breadth of views on type of Brexit (including about 30 eurosceptics)
DUP (10) - Alliance with Conservatives
Sinn Fein (7) Plaid Cymru (4) Green Party (1) Independents (1)
Liberal Democrats (12)
Bank of England
House of Commons (Lower House of Parliament, 650 seats)
British business associations
Chamber of Commerce & Industry
Society of Motor Manufacturers
and Traders
Labour Party (262) SNP (35)
British companies in favour
of EU membership
Includes: BP, Credit Suisse, BT,
Easy Jet, Vodafone, HSBC, Asda,
Marks & Spencer, Airbus,
AstraZeneca, BAE Systems, Rolls
Royce, Ryanair and Unilever
Trade Union Council (TUC)
British companies in favour
of exiting EU
Includes the CEOs of Phones 4u,
Reebok
Did note vote (13mn votes or
28% of registered voters)

5. 5
Differing opinions can of course be a source of good but only if they are channelled constructively. Instead,
an unsettling cycle of half-truths, empty promises, obfuscation of facts, platitudes and clichés – including
Theresa May’s “no deal is better than a bad deal” and “the best possible deal for the UK” have done little to
paper over the cracks of confusion at the heart of government. I argued in December that the British
government simply does not have a cohesive or comprehensive Brexit plan, only nebulous goals for the UK
post EU (see The A-Team had a plan, the British government has a nebulous goal, 13 December 2016).
The ruling Conservative Party, which has since lost its parliamentary majority, has given me no reason in
the past six months to change my mind.
Ripples of confusion extend well beyond government
This confusion is even greater at the parliamentary level, with few political parties showing consistency or
clarity of thought in terms of Brexit.
 The Northern Irish Democratic Unionist Party (DUP), which recently signed a formal Supply and
Confidence agreement with the Conservative Party, generally favours the UK exiting the EU.
However, the DUP has expressed a preference for Northern Ireland to maintain free-trade
arrangements with the Republic Ireland, which could be incompatible with the UK no longer being
an EU member (see UK election: Clutching defeat from the jaws of victory, 9 June 2017).
 The Labour Party, which has 262 seats in the 650 House of Commons, has been evasive on
whether the UK should stay in the Single Market and Customs Union, arguing instead that the UK
should enjoy the benefits which membership to these two entities convey. Divisions within the
Labour Party were exposed in recent parliamentary votes, resulting in party leader Jeremy Corbyn
dismissing a number of his shadow-cabinet members.
 Admittedly the pro-EU Liberal Democrats and nationalist United Kingdom Independence Party
(UKIP) have taken clearer (and diametrically opposed) positions on the Brexit issue. But they are at
best only marginal forces in British politics: the Liberal Democrats have only 12 seats while UKIP
has none and only won 1.8% of the popular vote in the recent general election.
Businesses and industry associations, including the Chamber of Commerce & Industry (CBI), have been
adding to the noise, pushing for the government to temporarily remain in the Single Market and Customs
Union beyond March 2019 until a fully-fledged deal has been reached.
EU leadership seemingly united on key principles and timeline
There is an argument that these multiple layers of confusion are intentional, part of the British government’s
strategy to hide its poker hand and keep the EU guessing, with the ultimate goal of securing a very
advantageous deal. Yet, European leaders have shown a sense of unity and little sign of wavering since
the British voted for the UK to leave the EU over a year ago.

6. 6
The head of the Brexit team, Michel Barnier, and political heavyweights including German Chancellor
Merkel, have steadfastly stuck to their position that membership of the Single Market is conditional on the
four freedom of movements, including importantly the free movement of labour (see Figure 3). The British
government has skirted around this issue ad-nauseam without spelling out how the UK could benefit from
frictionless trade with the EU whilst still controlling EU immigration.
Figure 3: EU-side of the equation also presents some complications although unity has reigned so far
Source: European Commission, European Council, European Parliament
European Council
1) 27 EU heads of state
2) Sets EU's policy agenda, does not negotiate
or adopt EU laws
3) Will have to vote on terms and conditions
of UK’s exit from EU and of any new deal
with the EU (Clause 2, Article 50 of Lisbon
Treaty)
4) President: Donald TUSK
European Parliament
1) Directly elected EU parliamentary institution
2) Will have to vote on terms and conditions
of UK’s exit from EU and of any new deal
with the EU (Clause 2, Article 50 of Lisbon
Treaty)
3) President: Antonio TAJANI
European Commission
1) Executive body of European Union
2) Responsible for proposing legislation, implementing decisions, upholding EU treaties and managing
EU's day-to-day business
3) President: Jean-Claude JUNCKER
EU Negotiating Team (main members)
Negotiates on behalf of 27 EU members states
Michel BARNIER – Chief Negotiator (French)
Sabine Weyand - Deputy Chief Negotiator (German)
Martin Selmayr – Cabinet Head of President of European
Commission Jean-Claude Juncker (German)
Didier Seeuws – Head of European Council’s Article 50 Task
Force (Belgium)
Stéphanie Riso – Director for strategy, coordination and
communication (French)
Georg Riekeles, Tristan Aureau, Randolph de Battista, Eugenia
Dumitriu-Segnana, Nicola Pesaresi, Ward Mohlmann, Tadhg
O’Brian, Aurora Mordonu, Thomas Liefländer, François Arbault,
Marie Simonsen, Peter Sorensen, Philippe Bertrand, Bence Toth,
Norbert Gacki, Antonio Fernandez-Martos, Nina Obermaier,
Stefan Fuehring
27 EU member states
Do not negotiate directly with UK
Austria, Belgium, Bulgaria, Croatia,
Cyprus, Czech Republic, Denmark,
Estonia, Finland, France, Germany,
Greece, Hungary, Ireland, Italy,
Latvia, Lithuania, Luxembourg,
Malta, Netherlands, Poland,
Portugal, Romania, Slovakia,
Slovenia, Spain and Sweden

7. 7
Similarly, the EU leadership was from day one unequivocal that an agreement on the terms and conditions
of the UK’s divorce should precede negotiations over a new deal. After months of posturing the British
government implicitly conceded that this sequencing would indeed prevail.
Only near-certaintyis that UK will likely leave the European Union
The closest thing we have to unity of thought and near-certainty is that the UK will leave the EU by 29th
March 2019 – two years after Theresa May triggered Article 50 of the Lisbon Treaty. Even pro-EU MPs
seem to begrudgingly acknowledge that the referendum result, which saw 52% of the electorate vote in
favour of the UK leaving the EU, needs to be respected.
However, there are still rumblings in the background of a second referendum and talk of the government
performing a giant u-turn and effectively aborting the Brexit process if it becomes clear that any new deal
would seriously hurt the British economy. EU leaders have blown hot and cold about the prospect of the UK
changing course and remaining in the EU but a number of senior politicians, including French President
Macron, have left the door open to such a possibility (it would be theoretically possible for the UK to cancel
the exit process but all 27 EU member states would likely have to agree to such a scenario).
The UK is scheduled to leave the EU in 21 months, which in practical terms is a very tight timeline but in
political terms is an eternity. While the probability of the UK leaving is high, in my view, it would be
foolhardy to assume that it is anywhere near 100%.
Vague fiscal policy new battleground for confusion
More recently, the debate about the optimal path for taxation, public spending and the budget deficit has
taken centre stage, driven by growing popular opposition to ongoing austerity measures. But again the only
consensus amongst senior cabinet members is that there is no consensus as to whether, when and how
taxes should be hiked to fund yet to be quantified or qualified public spending increases and/or whether
there is scope for fiscal deficit targets to be softened
Fiscal policy u-turns have become common currency, with the government flip-flopping on policies including
the 1% cap on public sector wage increases, the so-called dementia tax, national insurances tax, the triple-
lock on state pension increases1
and free school lunches. Ministers have been forced to repeatedly
backtrack, playing catch up in trying (and failing) to mask shifting official positions and present a united
front. Boris Johnson has in recent days publicly called for an end to the 1% cap only to be rebuffed by
Theresa May and Chancellor Hammond who clearly favour tighter fiscal policy.
Part II – Confusion is structural, cyclical and partly self-inflicted
The underlying causes for these multiple-layers of confusion are both structural and cyclical. I would argue
that 1) poor sequencing, a lack of preparation, no precedent and a tight timeframe with regards Brexit, 2)
1 The triple lock policy ensures that the state pension rises each year by the highest of one of three measures: wage
growth, inflation or 2.5%.

8. 8
the recent general election result and shifting popular opinion and 3) the multiplicity of economic challenges
have fuelled confusion and in turn exacerbated uncertainty.
Brexit: Poor sequencing, lack of preparation, no precedent and time running out to complete
immensely complex project
For starters, then Prime Minister David Cameron stacked the odds against the government’s official
position that the UK should remain in the EU by not allowing sufficient time to renegotiate a new EU deal
and by holding the referendum on EU membership before the parliamentary vote – unlike Prime Minister
Edward Heath’s Labour government in the 1975 referendum on EC membership (see Figure 4).
Figure 4: Government had 1975 referendum as a template but chose to ignore it
Source: British Parliament
Putting aside the issue of sequencing, one obvious reason behind the confusion regarding Brexit is simply
that Prime Minister David Cameron’s government had simply not planned for the eventuality of a “leave”
vote at the EU referendum on 23rd
June 2016. The broad-based assumption was that the deal which he
had secured with the EU in early 2016 would push the balance of popular opinion comfortably in favour of
“remain”. The then Chancellor Osborne had explicitly stated that the Treasury had been focussed on
negotiation talks with EU leaders and had not made contingencies for a possible exit from the EU.
June 1975 referendumon UK membership of the European Communities (EC)
Prime Minister Heath’s Labour government had the common sense of starting negotiating new terms
and conditions for the UK’s membership of the EC 18 months the referendum. It then signed a new
deal with other EC leaders in March 1975 and recommended a vote in favour of the UK staying in the
EC under this new agreement. On 9th
April 1975, 396 MPs voted in favour of the UK remaining in the
EC versus 170 against and two months later, on 5th
June 1975, the referendum was held with 67% of
the electorate voting in favour.
Had this sequencing been observed in 2016, it is conceivable that Prime Minister Cameron would
have secured a better deal with the EU, a majority of MPs would have voted remain (75% were in
favour of ongoing EU membership) and, as in 1976, the electorate would have followed suit and voted
“remain”.

9. 9
Figure 5: Europe’s current state of play offers a glimpse of what may be for the UK
Source: EU, EEA, EFTA
Note: (1) Formal agreement to use euro; (2) Operates in parallel with EU; (3) All 4 members of EFTA are members of EU
Single Market albeit with exceptions. Iceland, Liechtenstein and Norway are members of Single Market through the
Agreement on the European Economic Area (EEA) and Switzerland through bilateral treaties.
European
Union (EU)
European
Single
Market (3)
European
Union Customs
Union (EUCU)
European
Economic
Area (EEA)
Separate
customs
union with
EU
European Free
Trade
Association
(EFTA) (2)
Eurozone
Andora (1) x x x x  x x
Austria     x x 
Belgium     x x 
Bulgaria     x x x
Croatia     x x x
Cyprus     x x 
Czech Republic     x x x
Denmark     x x x
Estonia     x x 
Finland     x x 
France     x x 
Germany     x x 
Greece     x x 
Hungary     x x x
Iceland x  x  x  x
Ireland     x x 
Italy     x x 
Latvia     x x 
Liechtenstein x  x  x  x
Lithuania     x x 
Luxembourg     x x 
Malta     x x 
Monaco (1) x x  x x x x
Netherlands     x x 
Norway x  x  x  x
Poland     x x x
Portugal     x x 
Romania     x x x
San Marino (1) x x x x  x x
Slovakia     x x 
Slovenia     x x 
Spain     x x 
Sweden     x x x
Switerland x  x x x  x
Turkey x x x x  x x
United Kingdom     x x x

10. 10
The ruling Conservative Party then lost nine months clearing legal hurdles, drumming up parliamentary
support for Brexit and electing a new leader (Theresa May) and a further two months preparing for the 8th
June 2017 general election. As UK and EU parliaments and the European Council will have to vote on any
new agreement by end-2018, the British government effectively now has only 18 months to complete the
most complex legal, constitutional, political, economic, financial and social project undertaken by any EU
country in the past 40 years.
And of course there is no precedent for a country leaving the EU, no ready-made templates for the British
government to rely on. Proponents of Brexit have referenced Norway, which is not a member of the EU but
is closely associated with the EU through its membership of the European Economic Area in the context of
being a European Free Trade Association member (see Figure 5). But the comparison is far from perfect.
For starters, Norway is a significant net exporter of oil (and aluminium) which has funded one of the world’s
largest pension funds and affords it a degree of economic flexibility which the UK does not enjoy.
This lack of preparation and precedent and a (largely self-imposed) challenging timeframe have
undoubtedly compounded the sense of a government playing catch-up and the confusion which has
ensued. The outcome of the hastily called general election of 8th
June 2017 has only added fuel to the fire.
General election – Out of the frying pan, into the fire and self-inflicted confusion
Prime Minister May performed a remarkable u-turn in April by calling an early general elections, after
having strenuously talked down the need to hold elections only two years into the parliamentary term. This
decision back-fired with a weakened Conservative Party struggling more than ever for cohesion.
Theresa May’s motivations were four-fold: (1) Win a popular rather than party mandate, (2) Capitalise on
the massive lead in the polls the ruling Conservatives enjoyed over the opposition Labour Party and thus
allow her to push through her own agenda, including her preferred form of Brexit, (3) Allow the government
more time to secure a new EU trade deal, and (4) Strengthen the government’s stance in negotiations with
the EU (see UK election special – When two tribes go to war, 2 June 2017)
Objective (3) has to some extent been met as the current parliament will now extend to May 2022, rather
than 2020, potentially giving the government a further two years to secure a final EU deal. But objective (4)
was always wishful thinking and Prime Minister failed outright to secure objective (3). Most damaging,
however, was the Conservative Party losing both its absolute and working majorities (see Figure 6).

11. 11
Figure 6: Conservatives lost their working majority…and some credibility, adding to the confusion
Source: House of Commons
The minority Conservative Party subsequently signed a formal alliance with the DUP, which won 10 seats
and in theory should help the government get key policies (including on Brexit and the budget) through
parliament. But this marriage of convenience is fraught with problems and been much criticised. While calls
to oust Theresa May as party leader have abated, infighting within the party has gone up a notch and
senior cabinet members have been jockeying for power, exacerbating confusion over who truly is in charge.
Trade-offs more painful and confusion more acute as a result of slowing economic growth
There can be little doubt that economic growth in the UK has slowed this year. This does not bode well for
the government’s finances but perversely has intensified popular opposition to the government’s multi-year
austerity drive. Increasingly painful fiscal trade-offs have in turn seen government officials and MPs
increasingly divided as to the optimal path for fiscal policy. The fall-out has been growing confusion at the
heart of government as to whether, when and by how much public spending should rise and whether it
should be financed by higher taxes and/or greater borrowing.
 GDP growth was a paltry 0.2% qoq in Q1 2017 and macro indicators suggest it did not rise much in
Q2 (preliminary data are due out on 26 July).
 Slow economic growth, labour productivity now below end-2017 levels and a still reasonably large
pool of available labour (unemployed, part-time workers and those not in the labour force but willing
to work) are likely to continue weighing on workers’ ability to negotiate higher earnings and in turn
nominal wage growth.
 Falling real wages, pressure for banks to curb lending, stagnant property prices, a record-low
household savings rate and political uncertainty continue to hold back retail sale volumes (which
contracted 1.1% mom in May) and in turn household consumption and GDP growth.
Numberof seats in House of Commons Outgoing parliament New parliament
A. Conservatives (voting) 329 316
A.1 Conservatives (all) 331 318
A.2 Speaker and deputy speaker 2 2
B. Opposition (voting) 312 323
B.1 Opposition (all) 319 332
B.2. Sinn Fein 4 7
B.3 Labour deputy speakers 2 2
B.4 Vacant seat 1 0
Working government majority (A- B) 17 -7

12. 12
 Investment has slowed in a number of sectors. Investment in the auto sector in H1 2017 was
running at about a quarter of where it was only two years ago, as companies delay or shelve
investment plans.
 Export growth has picked-up but so has import growth, resulting in a still large trade deficit (despite
the 18% gain in Sterling competitiveness in the past 18 months) and little support for overall GDP
growth.
 On the supply side, industrial output has for the past 12 months continued to flat-line and the latest
manufacturing PMI data are not particularly encouraging.
Adding to the confusion is the fact that for the first time in almost a decade, the BoE is seriously considering
a policy rate hike (see GBP – Hawkish surprise presents selling opportunity, 15 June 2017).
Part III – Forecasts at the mercy of confusion (and uncertainty)
With this noisy backdrop, any forecast can be at best only tentative. However, I would conclude the
following at this stage:
1) I ascribe an 80% probability of the government sticking to its current plan to exit the EU by 29th
March
2019.
2) Assuming complex discussions about a new UK deal with the EU start no earlier than 2018, both parties
would have only 12 months to agree on the economic, financial, political and legal intricacies of such a
deal. This is arguably a very narrow timeframe, particularly for a Conservative Party short of a
parliamentary majority and which has so far moved very slowly.
With this in mind, it strikes me as very unlikely that a full-scale and permanent deal with the EU will be in
place by end-2018, which would leave the government with only two real options: walking away from a
deal and reverting back to WTO trading rules or agreeing to a transitional deal which buys the
government more time to contemplate its options. The latter is the more likely in my view and this could
include some form of borderless trade with the EU for a defined period in exchange for continued
contributions to the EU budget and a watered down version of the EU-immigration targets the
government currently has in mind.
3) With regards to fiscal policy, the path of least resistance could be for the government to adopt a middle-
of-the-road approach which includes an uptick in public spending (focused on wages rather than
infrastructure), small tax increases (particularly for higher income earners) coupled with a modest fiscal
deficit slippage this year and next. This would help alleviate calls for an end to austerity and not
materially damage the Conservative Party’s status as the more fiscally responsible of the major parties.
The Conservative Party has been in discussions with the left-leaning Liberal Democrats about the latter
supporting the government in parliamentary votes on a case-by-case basis. This suggests to me that the
government has, at the very least, not fully excluded modest increases in public spending even if the
scope for significant fiscal reflation remains limited.

13. 13
4) The BoE’s eight-member MPC is unlikely to hike its policy rates of 0.25% at its August meeting. While I
expect MPC member Andrew Haldane to join Michael Saunders and Ian McCafferty in voting in favour of
a 25bp hike, I expect new member Silvana Tenreyro to vote in favour of no change which would result in
a 3 versus 5 vote in favour of rates remaining on hold. Importantly, I believe that Governor Carney – who
has the casting vote in the event of a 4 versus 4 tie – will again vote for no change, even if he has had a
tendency to blow hot and cold.
5) Sterling may well continue to struggle for direction with the Sterling Nominal Effective Exchange Rate
(NEER) remaining in its year-to-date range (see Figure 7). But unless the government can post some
notable successes with regards to its Brexit negotiations, UK economic growth recovers or the MPC
hikes rates in coming months, at the margin I see the risk biased to Sterling downside from current
levels.
Figure 7: Sterling remains range-bound but risk biased to the downside in my view
Source: Bank of England, investing.com
92
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94
95
96
97
98
99
100
101
Oct 16 Nov 16 Dec 16 Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17
Sterling Nominal Effective Exchange Rate (23 April 2010 = 100)
General
election
MPC
meeting