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BREXIT should we be worried?
“Brexit” is not a disaster for the world economy
Once the dust has settled, the global economic implications of the UK’s vote to leave the European Union are likely to prove much less dramatic than many had suggested during the past few weeks. The adverse effects on the UK itself and the direct impact on other European economies should be small.
And there may be some offsetting benefits for the global economy, including looser monetary
conditions. However, the long-term political consequences could turn out to be far more significant.
The immediate focus is on the market turmoil triggered by the UK vote to leave the European Union. At the time of writing, sterling is down by around 8% against the dollar (compared to yesterday evening) and European equity markets have fallen by 5-10%. These are big moves for a single day and, if they are sustained, will have a negative impact on sentiment. However, the fall in sterling should not have any implications for the world economy as a whole. And the knock-on effects of falling asset prices for the economy need not be huge. After all, equity markets in advanced economies fell by over 20% in the first six weeks of this year but this did not trigger a recession, and these moves were soon reversed.
In brief, we think the adverse effects for the UK itself will be smaller than widely feared. It is likely that the process of leaving will not be initiated until October this year and that the UK will remain an EU member for at least two years after that. Investment may be weaker than it would otherwise have been – although note that officials are already trying to boost sentiment by stressing that Brexit is not, after all, the end of the world. But consumer confidence
should hold up well given that 52% of the electorate actually voted to leave the EU. Finally, while a sustained and large fall in sterling would lead to higher import prices, inflation should remain low by past standards, and a more competitive currency would give a boost to exports.
If we are right about the implications for the UK, it follows that the direct economic impact on the rest of the European Union should also be small. Indeed, even if the hit to the UK turns out to be much bigger than we anticipate, the consequences for other European economies need not be large because –
other than for Ireland – exports to the UK typically account for less than 3% of GDP.
Moreover, there are some silver linings. For a start, global monetary conditions may well be looser than they would otherwise have been. The Bank of England is likely to keep interest rates low for longer and, if necessary, may even announce further policy easing. The ECB will also be willing to consider not just an extension of its asset purchase programme but an increase in its size.
The UK referendum will not be a game-changer for US monetary policy, although it probably rules out a July rate hike. After all, Fed officials have cited the risk of a Brexit as a factor behind their decision to leave rates on hold in June and they may want to see how things pan out in the coming months before tightening policy. This has already been reflected in a fall in OIS rates and ten-year US Treasury yields, which have declined from around 1.75% yesterday to 1.5%. Brexit has also strengthened the case for further policy easing in Japan because of the appreciation of the yen.
Overall, therefore, the world economy should be able to weather the shock of the UK voting to leave the EU fairly well. Over the long run, the more important consequences may turn out to be political. Opinion polls show high levels of demand for a referendum on EU membership in France, Italy and the Netherlands; such demands may now be harder to resist. (See our European Economics Update, “UK vote to leave EU raises doubts over future of Europe,” also published today.) Moreover, even if the rest of the EU holds together, its members may struggle to agree on further reforms, including those which are necessary to sustain the monetary union.
Finally, the referendum result will exacerbate concerns that support for populist movements
elsewhere will continue to grow. This could prevent further progress with trade agreements such as TPP and TTIP and potentially reverse some of the liberalisation which has taken place in past decades. Support for Brexit in the UK and for Donald Trump in the US taps into the same concerns about the impact of globalisation and rising inequality. But parallels between the two movements are not as close as many assume, because the Brexit campaigners have argued for more, not less, free trade. For now, at least, fears of a wholesale reversal of globalisation appear over-stated.
Andrew Kenningham Senior Global Economist (+44 (0) 20 7808 4698, firstname.lastname@example.org)