BREXIT: FIRST-TAKE ON THE IMPACT FOR RETAIL First-Take on... · All parties expected a vote for...

1 DEBORAHWEINSWIG,MANAGINGDIRECTOR,FUNGGLOBALRETAIL&[email protected]:917.655.6790HK:852.6119.1779CN:86.186.1420.3016Copyright2016TheFungGroup.Allrightsreserved.

JUNE24,2016

BREXIT: FIRST-TAKE ON THE IMPACT FOR RETAIL

SterlingandEuropeanstockmarketswererockedbythevotefortheUKtoleavethe European Union. On the eve of the result, traders had expected the UKelectoratetovotetoremainintheEU.

In2017,UKGDPgrowthislikelytobebetween1%and1.5%lowerthanitwouldhave beenhad the vote gone the otherway. Butmajor banks do not forecast arecessionfortheyear.

In 2017, consumer prices are likely to be pushed up by a weaker pound, buteconomistsaredividedonthelikelyscaleoftheserises.

Weexpectretailsalesvolumestosoftenduetoweakerconsumerdemand,butthevalueofretailsaleswillbesupportedbyraisedinflation.

We expect this raised inflation to feed primarily into nonfood retail, given therelianceonimportsinnonfoodcategoriesandgiventhatstrongpricecompetitionwilllikelypersistinthegrocerysector.

THE UK VOTES FOR BREXIT

On June23, theUKvotedbya52%majority to leave theEuropeanUnionona voterturnout of 72.2%, the highest turnout in a UK national vote since 1992. In this flashreport,wesummarizetheimmediateimpactsofthevoteandlookatthemedium-termeconomicoutlook,withafocusontheimpactontheretailsector.

ThisreportisbeingwrittenonthemorningofJune24.ThevotefortheUKtoleavetheEUhitEuropeanstockmarketsandtheBritishpoundhard.Theeffectwasamplifiedby


JUNE24,2016

traders who confidently priced in a Remain vote on the day of the referendum. ThisexpectedvotewasapparentlydrivenbyopinionpollsthatshowedaleadfortheRemaincampaignandtheoddsonaBrexitofferedbybookies.

Atthetimeofwriting,theoverridingsentimentisoneofuncertainty,andweexpectthistocontinueforsometime.ThisuncertaintyisoverthetimescaleoftheexitfromtheEU(oreventheformalnotificationtotheEUoftheUKsplantoquit)andthenatureofthatexit.PrimeMinisterDavidCameronwillstepdownbyOctober2016,withhissuccessorlikelytoleadtheexit.

EvenaftertheUKhasadvisedtheEUofitsintentiontoleave,ithasuptotwoyearsinwhichtonegotiateandcompletethatprocess.Thisaddsgreatuncertaintytoestimatingtheoutlookforindustries.

SHORT-TERM IMPACTS

Allpartiesexpectedavote forBrexit tohavean immediate impacton thepoundandstocks,andwecertainlysawthat:

TheBritishpoundinitiallyfellbyaround10%againstthedollar,butatthetimeofwritinghasrecoveredalittletoaround7%down.

The FTSE100 Index initially fell by around6%,but at the timeofwritinghasrecovered some lost ground and is down around 4%.On a one-month basis,however,theindexisdownbyonly1.7%.

The FTSE 250 Index initially fell by around 12%. One a one-month basis, theindexisdownbyaround6%.

The FTSE 350 Index of General Retailers initially fell by around 12% beforerecovering,andisdownbyaround9%.

Major UK retailers slumped after the market opened, with discretionary-category retailers hardest hit:Marks & Spencer was down 19%, Debenhamswas down 21%, Next was down 25%, Sports Direct was down 27%, DixonsCarphonewasdown30%andWHSmithwasdown31%.


JUNE24,2016

MEDIUM-TERM EFFECTS

GDPGrowthSettoWeakenButRemainPositive

NobodyknowstheextenttowhichBrexitwillimpacteconomicgrowth,soeconomistsforecastsfor2017rangefrompositivebutweakergrowth,toarecession.

Citi forecasts that in2016and ineachof theyears to2020, therewillbeahit to realGDPgrowthofbetween1%and1.5%.Thebankdoesnot,however,forecastarecessiononanannualbasis,withrealeconomicgrowthofaround1%ineachyear.

Figure1..CitisForecastUKRealGDPGrowth(%)

Recreatedfromagraphprovidedwithoutabsolutenumbers.

Source:CitiResearch

INGforecastsGDPgrowthtoslowto1.5%in2017,some1.2%belowwhattheyexpectitwouldotherwisehavebeen. In2018, INGexpects thisdownwardpressureonGDP toreducetoaround0.7%.LikeCiti,INGdoesnotexpectarecessiononanannualbasis.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2015 2016E 2017E 2018E 2019E 2020E

Remain Brexit


JUNE24,2016

Figure2.INGsForecastUKRealGDPGrowth(%)

Source:ING

The Economist Intelligence Unit (EUI) forecasts a 1% fall in real GDP in 2017. Thiscompares to a +2.24%GDP forecast by the IMF prior to the Brexit vote. In turn, thisimpliestheEIUexpectsaswingofmorethan3percentagepointsineconomicgrowth,whichseemsundulynegativetous.

Consumer Prices Expected to Rise

Overthemediumterm,anexpectedweakerpoundwillpushuptherateofconsumerpricesinflation(CPI).However,economistsaredividedonthescaleoftheserises.

CitiestimatestheBrexitvotecouldaddaroundtwopercentagepointstoUKCPIineachof2017and2018,andpushitupfrombetween1%and1.5%tobetween3%and3.5%.

The EUI expects consumer prices inflation to be only slightly above the Bank ofEnglands2%targetinboth2017and2018.

INGexpects inflationtobepusheduponlymodestly: in2017, INGexpects inflation intheBrexitscenariotobe3.2%versus3.0%fortheRemainscenario.

1.01.21.41.61.82.02.22.42.62.83.0

2016E 2017E 2018E 2019E

Remain Brexit


JUNE24,2016

Figure3.INGsForecastUKCPIGrowth(%)

Source:ING

Retail Growth Likely to Soften

The risk of Brexit to retail and other consumer-goods industries comes from twosources: first, uncertainty on the timescale, shape and effects of exit from the EU;second,anydeleteriouseconomicimpactsofthatexit,orfromtheuncertaintyaheadofit.

TheEUIforecastsreal-termsretailsales(i.e.,volumes)couldfallbyaround3%in2017,comparedto+2%inthecaseofaRemainvote.Thiscomparestoareal-termsincreaseofaround4%ineachof2014and2015,andaveragereal-termsgrowthof4.4%overthe

1.0

1.5

2.0

2.5

3.0

3.5

2016E 2017E 2018E 2019E

Remain Brexit


JUNE24,2016

firstfivemonthsof2016,accordingtodatafromtheOfficeforNationalStatistics(ONS).Giventhiscontext,weviewtheEUIs forecastsasexcessivelypessimistic:wesee littlereasonforanapproximate7percentagepointswinginretaildemand.

Our firstestimatesare that theBrexit votecoulddent retail salesgrowthbybetween0.7% and 1% in each of 2017 and 2018.We show our first estimates for retail salesgrowth below.We base these on INGs expectations for GDP growth and CPIsomeelements of which take a conservative view of the Brexit effect relative to otherforecasts, such as those from Citi. Our figures are for retail sales growth in currentprices.

RetailvolumesarelikelytobesoftenedbymacroeconomiceffectsoftheexitfromtheEU. Yet raised inflation is expected to boost the value of retail sales in current-pricesterms.

Figure4.UKYoYRetailSalesGrowthEstimates

RetailValueGrowth:Remain

Scenario(%)

BrexitInflation

Impact*(%)

EstimatedBrexitVolumeImpact**(%)

RetailValueGrowth:Brexit

Scenario(%)2015 1.9 0.0 0.0 1.92016E 2.2 0.0 (0.5) 1.72017E 2.7 0.2 (1.2) 1.72018E 2.7 0.4 (0.7) 2.4

*ThedifferencebetweenINGsRemainandBrexitscenariosforCPI.

**We use the difference between INGs Remain and Brexit scenarios for real GDP growth as aproxyfortheimpactonrealretailgrowth.

Source:ONS/ING/FungGlobalRetail&Technology

We expect any inflationary pressures to be weighted toward nonfood retail for tworeasons. First, nonfood categories relymuchmoreon imports,whichmeans currencyeffectsarestrongerthan infoodcategories;second,weseetheongoinggrocerypricewarsaslimitingthepotentialforsolidpositivefood-priceinflation.

Figure5.PositiveandNegativeForcesinUKRetailValueGrowth

Source:FungGlobalRetail&Technology

Weakerpoundpushesupshopprices

Consumercaukonhitsdiscrekonary-purchasevolumes


JUNE24,2016

DeborahWeinswig,CPAManagingDirectorFungGlobalRetail&TechnologyNewYork:917.655.6790HongKong:852.6119.1779China:86.186.1420.3016deborahweinswig@fung1937.comJohnMercerSeniorAnalyst

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