By Ashley Kindergan From The Financialist

And so it begins. Even before the Brexit vote, corporate profits in the U.K. were already under pressure from a combination of sluggish global growth and rising wages. But now, several weeks after referendum, business confidence in the U.K. is officially cratering. Credit Suisse’s Global Markets team expects corporate pessimism to ultimately translate into reduced investment and hiring, and the combination of rising unemployment and a weaker pound to squeeze household income. With uncertainty high and optimism in short supply, the Global Markets economists foresee a recession beginning in the second half of 2016, and continued through 2017, during which they project a 1 percent decline in GDP.

Even setting aside the dramatic decline in sentiment in the wake of the referendum, the mere possibility of leaving the European Union was weighing on both British economic activity and corporate sentiment long before the June 23 vote. Economic growth fell from 0.7 percent in the fourth quarter of 2015 to 0.4 percent in the first quarter of 2016, and growth may have slipped further to 0.2 percent in the second quarter.

In May, a proprietary Credit Suisse survey of global executives showed that 40 percent of firms were postponing or cutting corporate spending in the U.K. in case British voters chose to leave the EU. Now that they have done so, 65 percent of firms say they are holding off on future investment, and for the first time since 2013, more firms say they are planning to cut spending in the U.K. than are planning to increase it. The U.K. Lloyds Business Barometer slumped to a four-and-a-half year low in June, and the YouGov/CEBR Business Confidence Index showed that the number of businesses that feel pessimistic about the future pretty much doubled from 25 percent to 49 percent in the week after the vote.

The stinginess in corporate boardrooms couldn’t come at a worse time. Corporate profits in the U.K. have fallen for the last two quarters, with the manufacturing sector absorbing a particularly hard hit. Meanwhile, the investor flight to safety in the wake of the vote has sent bond yields plunging, putting pressure on companies to increase their pension fund contributions. Zero interest rate policies implemented after the financial crisis had already pushed interest rates lower, which in turn forced down the discount rates used in pension funding models. As a result, British corporations (and American ones) have had to make higher payments to top up their pension plans. That trend is likely to continue, consuming cash that might otherwise have been used to invest in projects that stood a chance of boosting future growth.

But it doesn’t end there, either. In past British recessions, large drops in corporate spending are followed, after a lag, by declines in household spending. Growth in retail spending was running at a strong annualized 4 percent before Brexit, but consumer confidence is now hovering around levels last seen in the last quarter of 2007, in the days when financial crisis had begun thrashing its way around the globe. While unemployment of just 4.9 percent is as low as it’s been since 2005, economists on Credit Suisse’s Global Markets team expect deterioration there too, and think it will reach 6.5 percent by the end of 2017. With a weakening pound poised to make imports more expensive, the outlook for consumer spending over the next year and a half isn’t a rosy one.

In theory, a weaker currency should also boost net trade in Britain, but the increasing relative importance of imports in the British economy means that the overall effect won’t be as salutary this time around. In 1992, 45 percent of domestic goods sectors sourced between 80 and 100 percent of their materials from the U.K. By 2011, that proportion had fallen to just 15 percent. So a weaker pound will actually raise input costs for exporters, making a falling currency less of a boon for competitiveness than it might have been decades ago. Bright spots in the British economy are in short supply these days.

IMAGE: London – The Houses of Parliament and the Big Ben

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