After a tumultuous week in politics, a new weekly index tracking the impact of Brexit has revealed an almost 30 per cent rise in overall stress levels in the UK economy over just one week.
The RSM Brexit Stress Index – which tracks the impact of Brexit on trade, wealth, the business cycle and corporate profits – increased to 0.71 points above neutral in the week ending 22 March, up from 0.55 in the previous week.
To put this into context, it is important to note that the index has declined from over 2 points above neutral in December 2018, mostly due to financial markets pricing in a reduced probably of a hard exit from the EU. However, the events of the last week could mark the start of a reversal of this trend.
Over the last week, the factors pushing the index higher were primarily volatility across the foreign exchange markets linked to declines in the value of the pound. The FTSE 100 also fell on the week amid the political fallout from the European Council summit.
The RSM Brexit Stress Index tracks the weekly performance of six variables – the pound/euro exchange rate, the volatility of the pound/euro exchange rate, the performance of the equity market, the volatility of the equity market, the yield curve spread and the corporate yield spread.
These variables are combined into a single measure and assessed against a baseline 'normal' level of stress in the economy. The baseline zero score indicates neither an increase or decrease of stress in the system. The index is designed to give forward-looking investors, business executives and policymakers an instant snapshot of the economic impacts of Brexit.
Simon Hart, RSM's Brexit lead partner said: 'The political events of the last week have understandably put greater pressures on the UK economy. The factors driving the index into higher stress levels were primarily the volatility across the foreign exchange markets linked to declines in the value of sterling and the FTSE 100 decline on the week amid increased volatility over the past few days.
'Should the coming days produce similar political turmoil as last week, policymakers, middle-market business leaders and investors can expect stress in the financial markets to increase sharply, creating risks of a spillover into the real economy that would further depress productivity-enhancing investment in the UK. In those circumstances, the RSM Brexit Stress Index would increase in the week ahead.
'In addition, over recent weeks, we have seen more evidence of a slowdown in economic activity in both the US and Germany which has raised the risks of global recession over the next 12 months.
'This combination of stress related to the path of policy on Brexit and the increasing global headwinds faced by the British economy point towards more difficult challenges ahead for UK economic policymakers. Whatever the outcome of the next few weeks of negotiations, the government will need to find ways of stimulating the domestic economy, driving up private fixed business investment and reducing business uncertainty.'
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.