Since the vote in June 2016, firms have hoarded their cash. A softer Brexit could encourage them to start investing again.
By all accounts, business investment should be booming. Profit margins are above long-run averages and credit, thanks to loose monetary policy, is still cheap. The labour market has tightened and government policies such as the National Living Wage and pension auto-enrolment have upped the cost of labour. At the same time, many firms are at or near capacity after nine years of economic expansion.
Yet business investment has been relatively sluggish, given the macro picture. The reason? In the face of Brexit uncertainty, firms have spurned investment, opting instead to save their cash.
The Bank of England recently concluded from its Decision Makers Panel that as a result of Brexit uncertainty, nominal business investment around 3 to 4 per cent lower than it otherwise would have been.
As economic consultancy Pantheon Macroeconomics notes: ‘Business surveys clearly indicate that Brexit is to blame for the decoupling between investment and current economic fundamentals.’
In the first four quarters after the referendum, ‘firms accumulated a record £57 billion in currency and deposit holdings,’ says Pantheon Macroeconomics. They have continued to accumulate cash since, although at a slower rate. UK firms’ currency and deposit holdings are now at a record-breaking 37 per cent of GDP, up 5 per cent from the referendum.
The surge in cash holdings isn’t solely a reflection of the decline in firms’ investment. Structural changes have also encouraged cash hoarding. For instance, companies now often rely on internal financing for expansion, as intangible assets – increasingly important for businesses – can’t be used as collateral for loans.
Nonetheless, a large amount of that surge in cash savings has come from businesses declining to invest in the face of Brexit uncertainty, leading Pantheon Macroeconomics to speculate that a softer Brexit ‘might unlock a wave of investment.’
Whether a softer Brexit will be achieved, however, remains uncertain. The prime minister’s most recent proposal, while softer than anything proposed before it, will most likely be rejected by the EU, at least in part. At the same time, the proposal, and now the prime minister, face fierce opposition from hardliners within the Conservative Party.
‘Nonetheless, we still see scope for an upturn in capital expenditure next year,’ says Panthenon Macreconomics. The consultancy expects investment to rise to 3 per cent in 2019 from 0.8 per cent this year, and GDP growth to rise to 1.7 per cent.