The UK has voted to leave the EU and there has been a series of shocks felt through the political establishment, likely in the economy and financial markets. Here are a few initial thoughts and observations of the impact of Brexit.
The Political fallout from Brexit has created some serious questions in UK political leadership.
- What happens to the Conservative Party? This was always going to be an issue but clearly more so with the Prime Minister resigning, what happens to Chancellor Osborne? A new leader needs to be seen as soon as possible to help stabilise the ship, but this could still take a couple of months. Will this drive continued market uncertainty for the coming weeks?
- Implosion of the Labour leadership – a raft within the shadow cabinet with swathes of resignations could prompt another divisive leadership battle.
- Also, what does this do for the renewed prospect of Scottish independence? In the wake of Brexit around 59% of Scots would now support independence in one poll. Scottish First Minister Nicola Sturgeon has placed the issue firmly on the agenda. This is not to be unexpected but this is a seriously opportunistic move from Sturgeon and one that will not help the stability of the UK economy.
The impact on the economy is clearly too early to ascertain, but there is an expectation for:
- Lower growth
- Higher inflation
- All leading to uncertainty over monetary policy
In the wake of the Brexit decision, the likelihood is that the UK could now go into recession. Clearly there is a range of expectations. Goldman Sachs forecasting a mild UK recession in 2017 – forecasting a cumulative 2.75% hit to GDP in the next 18 months, whilst Bank of America Merrill Lynch is suggesting just +0.2% GDP in 2017. Whether the UK goes into recession or not, all are suggesting some sort of economic slowdown. However, the prospect of the UK moving into recession could have a significant impact on the decisions taken by the Bank of England.
Impact on inflation
The enormous sterling weakness (a sell off of around 1800 pips since last Thursday) means the UK could import inflation. With the large trade deficit and foreign goods would be more expensive. Some estimates have suggested this could drive inflation up towards 4% by the end of 2017. What does this do for monetary policy?
Impact on Monetary policy
However falling growth and rising inflation all adds up to one big headache for the Bank of England Monetary Policy Committee. All depends upon the degree of negative growth and rise in inflation. Mark Carney has said the Bank of England will put in place measures to preserve financial stability, and it is prepared to inject an extra £250bn of bank liquidity to avoid running short of cash. Carney has also avoided any knee jerk moves on interest rates or extra quantitative easing, which must be seen as the correct response as it could be seen as a panic response. Instead opting for a wait and see mode instead as the bank assesses the economic impact. Therefore it could be a while (possibly even months) before the Bank makes a move, if at all.
What could be the impact on UK jobs?
It is though arguable that wages could go up now following Brexit – perhaps one of the reasons why swathes of lower income voters may have chosen to vote Leave? With less supply of cheap labour from the freedom of movement, this could push up the cost of labour. The problem would be that this could be balanced by companies pulling out of the UK due to the removal of access to the EU.
This is especially the case with investment banks which are already talking about the number of job losses. HSBC has threatened to cut 1000 jobs, whilst the US banks are also threatening a tactical withdrawal of some departments from the UK. JP Morgan and Morgan Stanley have both said around 1000 could go, whilst Citigroup could cut 2,000. It is no certainty to the decisions yet but the threats are coming and that is not helpful for those employees and the prospect of retail spending, home purchases, spending money on holidays etc. What impact could this have on the economy going forward? One thing for sure, it will not be positive.
In forex there has been a massive sell-off in sterling and a move into safe haven assets. Sterling is getting slammed, but the big question is what will be the bottom? Already Cable is at the lowest since 1985, a 31 year low, but where does it stop. Down at $1.3200 that is an 11% fall in just two days. Prior to the vote estimates were talking about 15% to 20% downside from around $1.4500 (around where Cable has been trading in the past few months) that would equate to around $1.2300 and maybe as far as $1.1600. I am expecting much volatility in the weeks ahead with the huge uncertainty over the economic impact.
Equity markets lost over $2 trillion on Friday and the most since the height of the global financial crisis in 29th September 2008. The biggest impact seems to have been seen on the banks sector due to uncertainty over the EEA passporting of services. On Monday, the Stoxx600 Banks index has been down over 7% as banks have been downgraded by analysts today, with Societe Generale and Jeffries downgrading the sector. Barclays shares down 15%, whilst UK financials are also under huge pressure across the board. Furthermore, UK focused companies such as retailers and housebuilders are being smashed. The longer the fear and uncertainty continues, it will be difficult to see a discernible improvement in their prospects.
However, interestingly there are the winners in this situation too. The precious mining stocks Randgold and Fresnillo are strong. Oil giants Royal Dutch Shell and BP are trading at 2016 highs with their dividends paid in dollars and significant overseas revenues they are benefitting from the sterling weakness. However, as an index, with half of the revenues of the FTSE 250 companies (mid-caps) being UK based then this index is struggling due to the broad exposure to the UK economy.
Gold also continues to climb having broken out above $1306. Also Treasury yields continue to fall, both at levels not seen since 2012. The prospects of a Fed rate hike are being pushed further into the future too, with CME FedWatch no longer pricing in a rate as likely this year. Once the market volatility settles, perhaps this will be seen as a positive for risk appetite, however for now there is little prospect of this as fear continues to drive market moves.