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Flying the Flag

  • 24Aug 16
  • Susan Anderson Senior Investment Strategist, Investment Solutions

Holidaymakers heading to the Italian Riviera this summer may be surprised by an unusual sight; that of Union Jacks flying over the beaches and cafes around Rapello. They are part of a local protest against the European Union (EU) and its ruling on opening up competition in seaside concessions on the Italian coast.

The Financial Times reported the story on 5th August and commented that the adoption of the Union Jack is a sign of how anti-EU movements have seized on the UK’s decision to leave to bolster their case. This example could be dismissed as a one-off but it occurs at a sensitive time when there is a pending referendum in Italy on constitutional reform. The future career of the Italian Prime Minister, like that of David Cameron, may well be decided by the referendum outcome and his defeat would lead to another election in a year of elections across Europe. The Union Jack flying in unexpected places in Europe is an example of the growing trend in populist politics across principally developed economies - perhaps best epitomised by the rise of the US Presidential candidate Donald Trump.

It’s a response to the years of austerity measures and subdued growth that have followed the Great Financial Crisis. Since 2008, measures to rescue the financial system and avoid depression have been dominated by monetary policy. Central banks have taken the lead while governments have cut budgets. The outcome is a growing disparity in wealth by region and class. The main beneficiaries of central bank policy are the owners of assets while average earnings have stagnated. Although employment has recovered it’s been a slow process with no real growth in wages. The recent UK vote to leave the EU was partly a protest against the establishment and austerity by working and middle class voters.

Ironically, for those socio-economic groups hardest hit, Brexit means that the UK economy now faces the prospect of recession in 2017 with implications for both employment and wages. After GDP growth of 1.5% to 1.8% in the current year, the UK rate of GDP growth could slip to between nil and 1.1% next year. Longer term, no one knows what “Brexit means Brexit” will look like and how long the divorce will take. However, monetary and fiscal policy in the UK is in the process of responding. On 4th August, the Bank of England slashed its economic forecasts and announced a slew of measures which included cutting the official rate to 0.25%, buying up to £10bn of corporate bonds along with a new scheme to provide funding for banks in this ultra-low rate environment. The fiscal part of the response may become clearer with Philip Hammond’s first Autumn Statement in November. The new UK Chancellor hinted at this in his recent comments that the UK may have to “reset” fiscal policy. Perhaps not surprising since the previous incumbent, George Osborne, abandoned his budget targets and announced a corporate tax cut immediately after the referendum.

With official interest rates at zero and negative in some parts of Europe and Japan, it can be argued that monetary policy is reaching its limits.

With official interest rates at zero and negative in some parts of Europe and Japan, it can be argued that monetary policy is reaching its limits. There are now tentative indications that governments will have to step up and implement fiscal policies. Such measures could include tax cuts and infrastructure spending. Economists have been debating when governments might share some of the responsibility with the central banks. The UK’s vote to leave the EU may prove to be the catalyst for Eurozone governments to rethink their policy options.

So, if you’re heading off on your holidays, look out for who’s flying the British flag. It could be a clue to the Eurozone’s future.

Sources: Aberdeen, Oxford Economics, ASR and the FT

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