The RSM Brexit Stress Index eased last week, as Parliament took additional steps to prevent a no deal exit from the European Union.
The index fell to 1.24 standard deviations above normal levels of stress at market close on Friday, down from 1.42 a week earlier. Though still high, this suggests an improvement from the difficult conditions of just two weeks ago.
By the end of the week, Parliament had rejected a bid by the Prime Minister for a snap election. Meanwhile, Scotland’s highest court found the Government's suspension of Parliament to be illegal. The Supreme Court hearing to rule on the legality of the prorogation of Parliament is now underway.
Before Parliament took control of Britain’s impending departure from the European Union, the index—a composite measure of the financial market—was registering almost two standard deviations above normal. High levels of financial market stress are associated with pullbacks in lending and borrowing practices, and slower economic growth in coming quarters.
Recent economic releases show that UK growth is already trending downward into a climate that could easily stumble into recession. Growth in the manufacturing sector has been negative for four straight months, and the rolling three-month growth of GDP was slightly negative in June and at zero in July.
Recent employment data also indicate that UK employment growth continues to decelerate while wages increase, which is to be expected at the end of an economic expansion.
The increase in wages could also be a factor in the Bank of England’s wait-and-see response to the global economic slowdown and the Brexit ordeal. The financial markets are giving only a very slight chance of the BoE cutting its base rate on Thursday, despite last week’s dramatic action by the European Central Bank and the expected rate cut by the Federal Reserve today.
Commenting on the latest index score, Simon Hart, RSM's Brexit lead partner said: 'While the Brexit Stress Index has eased, the risks of volatility have not gone away and recessionary-style economic headwinds do appear to be increasing.
'This week's meeting in Luxembourg has underlined the challenges facing the Prime Minister as he tries to secure a deal. Meanwhile, the outcome of the Supreme Court hearing adds further uncertainty into the mix.
'The last week has also been a reminder that Brexit is just one of a number of challenges facing the global economy. The attacks on the Saudi Arabian oil facilities affecting 5 per cent of global supply, and the risk of a ratcheting up of tensions in the Gulf are also likely to affect the real economy, in the UK and around the world. We can expect fuel and food prices to be affected almost immediately as a result.'
The RSM Stress Index tracks six variables:
1. British pound/euro exchange rate
An exchange rate measures expectations of relative interest rates and the demand for one currency relative to another due to trade and current account flows.
2. Volatility of the British pound/euro exchange rate
Low volatility suggests a stable environment in which to make investment or trade decisions. A spike to high volatility indicates uncertainty in the market.
3. Equity market performance
In the absence of shocks, stock indices show a tendency to grow over the years. We look at the weekly level of the FTSE 100 Index relative to the same week of the previous year.
4. Equity market volatility
Spikes in the volatility of the FTSE 100 suggest the potential of a shock and an environment of uncertainty.
5. Yield curve spread
A steep yield curve indicates the market expects sustained, long-term growth. A flat yield curve indicates the market is expecting low levels of growth.
6. Corporate yield spread
The corporate yield spread measures the risk of holding a corporate security versus the safety of a risk-free government security. The higher the spread, the more the perceived risk of economic distress and the prospect of corporate defaults.