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Markets steeled for Brexit fallout

This article is part of
What next for the UK? - July 2016

Markets steeled for Brexit fallout

The unexpected decision by the UK to leave the European Union has brought forward forecasts of recession in the UK and the need for clear actions by both governments and central banks.

As a political rather than an economic shock, the effect of the result on the economy is more indirect in the short term, delivered through the financial markets and the knock-on effects on business and consumer confidence, says Ian Stewart, Deloitte’s chief economist in the UK.

He explains: “[June 24] saw a flight from riskier assets, such as sterling and equities, to safer assets such as gold, government bonds, the yen and the dollar. If sustained, declining financial market risk appetite tends to feed through to weaker risk appetite in the corporate sector. Companies react by battening down hatches, paring investment and sharpening their focus on cost control.

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“Foreign investors may also take fright and hold back on investing in the UK. Since the UK needs overseas capital to cover its current account deficit, the result of such a buyers’ strike would be a further weakening of the pound.” He points out that to generate a full-blown recession “consumers, who account for two-thirds of GDP, would need to stop consuming, as they did in 2009-10”.

But he adds: “The worry is that a toxic combination of uncertainty and a squeeze on spending power from high inflation and weaker earnings does just that.”

Dominic Rossi, global chief investment officer for equities at Fidelity International, noted on June 24 that the decision “will fundamentally change the way we administer our laws, our regulation and trade agreements. It leaves business leaders and investors in a period of unprecedented uncertainty for the UK. I think we have to realise there will be a negative economic effect in the immediate future.”

While Mr Rossi points out the UK economy has performed well in the past couple of years, he adds: “I think it’s unavoidable we will experience a recession. It will be mild compared with 2008-09, with rising levels of unemployment and falling demand and some relief from exports from a weaker currency. I see us coming out of this recession in 2017.

“I think this is a shock and shocks tend to hit economies relatively quickly, so I think we’ll probably start seeing signs of deceleration over the summer.”

A key element in stabilising the economy will be actions taken by the government and the Bank of England (BoE), with Mr Stewart noting the most useful response “would be for the government to signal the direction of travel for the UK in its negotiations with the EU. In markets and business as in life, intent matters”.

Meanwhile, in the days following the referendum result, chancellor George Osborne ruled out the immediate introduction of a so-called “austerity Budget” that had been mooted in the run-up to the vote.