In the two months that have passed since the Brexit vote, many questions have been asked but as yet we’ve not had too many answers. It will be some time before the full implications of Brexit are known and we see exactly what a post-Brexit UK will look like but the days since the referendum have provided a glimpse of what is in store while that picture takes shape. While the new Prime Minister Theresa May and her Cabinet in Westminster decide on a Brexit strategy and then implement it the UK faces a protracted period of uncertainty that presents businesses with both opportunities and challenges.
One of the most immediate and obvious effects of the decision to leave the EU was seen in currency markets. At time of writing since June 23rd GBPEUR has fallen 12% and GBPUSD some 14%. Commercial property prices have fallen around 10% with the result that some property funds have closed their doors to withdrawals for a time. Furthermore the latest (July) Purchasing Managers Index data showed a sharp fall to 48.2 from 52.4 in June, indicating a contracting economy and reflecting a dramatic weakening in sentiment. However, to date we have been very short of hard economic data releases. This has meant the Pound has slipped in the face of negative sentiment and uncertainty over the UK’s immediate next steps. There was some relief for the markets when a new Government was installed quickly but since then the only proclamation from the new Chancellor on the future direction of economic policy has been a line that he may use the autumn statement to “reset” UK fiscal policy. The autumn statement is due in either late November or early December.
The Bank of England has filled this vacuum by reacting with calm and decisiveness to try and head off a recession for the UK economy. On 4th August the MPC cut interest rates by 25bps taking the base rate to 0.25%, started a QE programme for £70 billion and set up a new Term Funding Scheme making £100 billion of liquidity available enabling businesses to borrow at the new lower rates. BoE Governor Carney stressed that if the UK economy continued on the path that it expected then they would cut interest rates again and would consider increasing and extending QE if the economy needed it. In acting this way, the BoE is buying the Government time and trying to build confidence in the UK economy.
The market is now looking for three things in the immediate future:
- Hard economic data that shows how UK economy has fared since June 23rd
- Clear direction from the Government on what steps it will take post the Brexit vote
- When Article 50 of the Lisbon treaty will be triggered.
Hard economic data will allow the market to correctly price sterling. If it shows a softening in the UK economy and a widening of the current account deficit QoQ (due out on September 27th) the pound is probably due for another leg lower.
The Government’s approach to renegotiating its relationship with the EU will also be closely watched by the markets. Will it be able to retain passporting services while putting the UK back in charge of migration? It’s not completely without precedent. In 2004 Germany and France negotiated 7 year moratoriums on migration from Eastern European states that joined the EU in 2004. The UK, which was short of labour at the time allowed such workers in straight away. Does this open the door to an agreement that gives the UK a seven-year emergency brake on immigration while keeping close trading ties? Is there a possibility that the negotiations can take place without even triggering article 50? If the EU is good at anything, its compromise and a settlement may not be as far off as is widely expected. The UK Government’s strategy and opening salvos could be key.
As to when article 50 is triggered the Mayor of London has already suggested that the UK won’t trigger Article 50 until next autumn. This makes a total of 36 months from the vote to the first possible date for Brexit. Three years of uncertainty and a possible reduction in foreign direct investment is unlikely to please the capital markets which are notoriously short term and do not like uncertainty. If the picture remains unclear for the UK economy for a prolonged period the chance of much lower levels in Sterling becomes more probable.
The only precedent for a country leaving the EU is Greenland in the 1980’s. It took them three years to agree departure terms and they mainly discussed fishing. For the UK to agree terms with 27 member states may take from here to eternity, in which case there is a high probability that Sterling will continue to weaken and remain volatile.
- GBPUSD H2 1.2000
- GBPEUR H2 1.123