Brexit aftermath - the only thing that remains certain is uncertainty
7 July 2016
The UK’s surprise popular vote to leave the EU has left a wake of destruction on financial markets. Moreover, the world is no more informed on the next steps forward on a UK exit of the EU than prior to the referendum. Many points of contention remain, from people questioning the validity of the result given its tight 51.9% to 48.1% margin, to those highlighting that it is not binding on parliament but merely advisory, demands of additional referenda with stronger criteria, the timing around and process of the exit, negotiation of new trade agreements and rules on migration, etc. Any way you cut it, even a week after the fact, it’s a mess.
So what do we know? As written previously on these pages, financial markets and businesses do not like uncertainty. This can be reflected in the sharp fall in the pound and decline on global equity markets as soon as the vote results became known. While there has been some recovery on equity markets in the days since (most notably in the UK where the FTSE100 index is currently trading above pre-Brexit vote levels, in part due to the risk of an imminent interest rate cut from the Bank of England (see below), many markets around the world are still well down from levels seen on Thursday 23 June.
What are some of the risks?
One significant risk is that the GBP loses its reserve status. This has been, in part, reflected in the sharp fall in the value of the pound on the foreign exchanges in the wake of the vote. One factor behind this is that the UK just lost its last AAA credit rating from the major credit rating agencies, meaning that in their eyes there is a higher (but still very small) chance of sovereign default. How Bank of England Governor Mark Carney’s words ring in our ears - will the UK still be able to rely on “the kindness of strangers” to finance its current account deficit of the nation’s financial assets no longer appear as valuable? This could mean that it becomes more costly for the UK to attract capital over the longer term.
Recession in the second half of 2016 is also a significant risk - with the future of the UK economy so clouded (trade negotiations, freedom of movement, timings etc), the incentive for firms to invest and employ has been significantly diminished. Worried consumers will also likely tighten their purse strings. Indeed, in acknowledgement of the materially negative impact that the Brexit referendum has already had on the outlook for the UK economy, Bank of England Governor Mark Carney warned that official interest rates could be reduced from already historic lows at 0.50% in order to support activity (even after accounting for the partial support that will be provided to the export sector from the sharply weaker currency).
While the pound has recovered a little ground following its sharp plunge on foreign exchange markets, don’t expect it to return to pre-Brexit vote levels anytime soon. Indeed, the risk is for further downside moves as uncertainty remains high and the likelihood of more bad news stays on the cards. Brexit will not be resolved in a hurry - it will be years before any firm outcome is known.
The Debtze Economist