3 min read.Updated: 25 Jun 2016, 02:07 PM ISTJill Ward
Investors responded to the Brexit referendum by selling UK stocks and pushing the pound to the lowest in three decades, while PM David Cameron said he'll step down
London: Life’s not getting easier for the UK economy.
With growth already losing momentum this year, Britain’s decision to quit the European Union adds a layer of economic, political and market insecurity that may act as a further brake. Investors responded to the referendum by selling UK stocks and pushing the pound to the lowest in three decades, while Prime Minister David Cameron said he’ll step down.
As Bank of England governor Mark Carney focuses on the immediate task of cementing the financial system’s defenses against the Brexit-fuelled market turmoil, he’ll also need to keep an eye on longer-term implications. He acknowledged that in his response to the vote on Friday, saying policy makers will keep assessing the situation and can take more action if needed.
“The question is: Is the fall in markets we’ve seen the end? I suspect it isn’t," said Danny Blanchflower, a former BOE policy maker and now a professor at Dartmouth College. “This looks like a big negative shock to output, and we’re going to see some move to stimulus."
In addition to potentially putting another dent in the economy, the referendum fallout is another moving part that BOE officials must digest as they calibrate policy settings. With the economy heavily reliant on consumers and trade acting as a drag, growth slipped down a notch at the start of the year. That slowdown may deepen, with institutions ranging from the OECD to the UK Treasury having warned that leaving the EU would wreak damage on the economy.
The investor reaction to the vote was immediate, with mayhem in global financial markets on Friday, and the fallout has just begun. Uncertainty that had already shaken the economy in the run up to the vote — curbing investment and hiring — will likely persist now, exacerbating existing problems, including a record current-account deficit.
The divorce sets the UK up for years of bitter talks with European leaders, meaning the UK’s ability to trade freely with the bloc, its “passport" for financial services and the free movement of people are all at stake.
“The uncertainty running up to the vote was already at an epic high for Britain," said Nick Bloom, an economics professor at Stanford who specializes in uncertainty. “Now it’s completely unknown what will go forward in terms of trade relationships, financial and legal relationships with Europe, domestic policy, how will Europe respond -- there are just so many factors."
The BOE said in the minutes of its interest-rate decision this month that jitters in the run up to the vote were already delaying “major economic decisions" such as business investment, real estate transactions, and car purchases.
The slowdown could affect Europe, according to Morgan Stanley, citing direct trade spillovers, financial-market ripples, and weaker confidence. The IMF has warned that the Brexit fallout may reach the global economy.
In the UK, higher inflation is also a risk if the pound’s weakness proves persistent. Sterling was below $1.36 late on Friday, down from $1.49 the previous day.
That leaves the BOE with a tradeoff between stabilizing inflation and boosting output. Investors predict policy makers will opt for the latter, with traders pricing in a 40% chance of an interest-rate cut by the MPC’s July meeting.
“There is going to be a further negative impact on growth, but it’s hard to gauge the amount at this point," Azad Zangana, an economist at Schroders, said by phone. “We suspect households will cut back spending anyway, just because of fear around the impacts from Brexit, but also because inflation is likely to pick up now."
It will take time to see how businesses respond to the decision and whether they cut back on employment, Zangana said. Any increase in joblessness could also have a knock-on effect on consumption -- bad news for an economy so dependent on consumer spending.
Samuel Tombs, an economist at Pantheon Macroeconomics, said a UK recession is likely given that the threat of Brexit alone “brought the recovery to its knees" this quarter. He sees heightened uncertainty damping capital spending while credit costs may rise. Nomura also sees a recession, with a peak to trough GDP slump of 2%.
Others aren’t convinced yet.
“A lot of people are talking as though a recession is a certainty — I’m not sure that’s right," said former BOE policy maker Kate Barker. “As we stand today, nothing very much has changed, except we have a huge bout of uncertainty. That will take time to play out." Bloomberg
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