Over a year has gone by since the UK voted to leave the European Union (EU) and in around 18 months, Brexit will become a reality. This note summarises the story so far…
No great clamour for a second Brexit referendum
The UK voted to leave the EU on 23 June 2016. Over 30 million people voted in the referendum with a turnout in excess of 70%. The margin of victory in the referendum was relatively modest: the Leave campaign won by 51.9% to 48.1%, or 17.4 million votes to 16.1 million. However, the outcome has proved decisive. There has been no great clamour for a second referendum.
Three things happened in the immediate aftermath of the Brexit vote:
- a change in political leadership
- a dramatic policy response from the Bank of England (BoE)
- a re-rating of sterling
Theresa May rapidly succeeded David Cameron as Prime Minister
David Cameron announced his decision to step down as soon as the result became clear, creating a vacancy for both the leader of the Conservative party and prime minister. But there was no extended leadership contest and vacuum of power at the head of government: Theresa May was quickly chosen as his successor by her peers in Parliament. The new prime minister might not have had a mandate from the people, but she appeared to enjoy a considerable lead over the main opposition party in the polls.
The Bank of England took precautions…
The Bank of England (BoE) was concerned about the macroeconomic ramifications of the vote to leave the EU. Within a couple of months, the BoE had cut official interest rates (see Exhibit 1 below), tweaked its market operations to ensure the cut was passed through to households and companies and restarted asset purchases. The bank would go on to purchase another GBP 60 billion of government bonds and GBP 10 billion of corporate bonds.
Exhibit 1: On 4 August 2016 the Bank of England Bank cut the UK base rate to 0.25% and introduced a package of measures designed to provide additional monetary stimulus (changes in the UK base rate between 02/10/06 and 03/10/17)
Sterling was the shock absorber
The financial market’s reaction to the outcome of the vote was pretty immediate: the value of the pound fell as investors reassessed the likely path of UK interest rates, the attractiveness (or riskiness) of UK assets and the level of sterling that would be required to narrow the UK’s trade deficit post-Brexit. Having started 2016 at close to GBP 1.50 against the US dollar, sterling fell to around 1.20 in early September 2016 (see Exhibit 2 below). The currency is a natural shock absorber: sterling-denominated assets now looked cheaper – particularly stocks of companies who predominantly do their business outside the UK – ensuring that there was no buyers’ strike among international investors.
Exhibit 2: Sterling absorbed the shock of Brexit – graph shows changes in the pound sterling/US dollar exchange rate (10/06/06 – 06/10/17)
Source: Bloomberg, BNP Paribas Asset Management, as of 03/10/2017
The months that followed the Brexit referendum result were as notable for what did not happen as for what did…
There were no formal negotiations with the EU and there was no loss of economic momentum. These two facts were probably not unrelated.
Economists had expected a vote to leave the EU to trigger a marked slowdown in demand given evidence that increased uncertainty tends to weigh on consumption and investment. In the event, the economy continued to expand at a robust rate: quarterly growth in real GDP is currently estimated to have been 0.5% in Q3 and 0.7% in Q4. There are a number of plausible explanations for why the economy performed so well after the referendum result. Perhaps households and companies believed they would be better off as a result of Brexit and spent more accordingly. Alternatively, it might be that the referendum result had very little impact on spending decisions because nothing really happened afterwards: the uncertainty over who was running the country was quickly resolved and the uncertainty over the future was not apparent because the negotiations had not yet begun.
Economists may not have called the immediate impact of the referendum correctly, but their forecast of the medium-term implications have proved more accurate
As expected, the sharp depreciation in the value of the pound has led to a surge in import and consumer prices in the UK, driving inflation to above the BoE target and squeezing the real disposable income of UK households. CPI inflation is currently 2.9%, almost a percentage point above the BoE’s target, putting pressure on the Monetary Policy Committee to unwind some of the emergency monetary stimulus that was announced soon after the referendum result. Indeed, the latest set of Minutes suggests that interest rates may rise in the coming months.
After calling a snap general election, Theresa May lost her parliamentary majority…
The UK government formally declared its intention to leave the EU around nine months after the referendum result by triggering Article 50 of the Lisbon Treaty. However, within weeks, the prime minister had called a snap general election, arguing that she needed a stronger hand in the looming Brexit negotiations. To begin with, her lead in the opinion polls looked unassailable and suggested she was on course for a landslide victory, but she would ultimately lose her majority in Parliament, forcing her to enter into an informal coalition with the Democratic Unionist Party.
Brexit negotiations have begun, but reached an impasse…
The negotiations have now begun in earnest, with David Davis representing the UK and Michel Barnier representing the EU. At the moment, the talks have reached an impasse over the UK’s ‘divorce bill’ – the spending commitments that the UK made during its time as a member of the EU. The EU wants to make sufficient progress on this question and the issues of citizens’ rights and the border in Northern Ireland before the talks move on to the issue the UK cares about: the trade deal.
The UK government has struck a more conciliatory tone since the election and that bodes well. It seems increasingly likely that transition arrangements will be put in place, which will feel very much like continued membership of the EU (except that the UK will no longer have a say in how decisions are taken) and that can act as a bridge until the terms of the trade deal are agreed.
Written on 03/10/2017