Brexit: Life Goes On

A week after the UK public surprised the world by voting for “Brexit”, the dust is starting to settle in the financial markets and the political arena. The sudden volatility global markets experienced in the days following the vote was in large part due to positioning, or rather, the lack of positioning. Going into the vote there was a strong consensus in the markets that, in the cold light of day, economic self-interest would prevail. The resulting vote to leave thus precipitated a typical market shock, with risk proxies like equities initially selling off heavily, while safe haven assets such as US and German government bonds rallying. As this initial shock has now started to fade, markets have begun to price in the actual economic consequences more appropriately.

In market terms, “Brexit” is a trade dispute between two large and globally important economies. Through its EU membership the UK is a part of a free trading bloc covering 32 European countries. With this membership comes a host of obligations, including acceptance of considerable amounts of EU law and regulation. It also entails adherence to the principle of free-movement of labour – an issue that has become a lightning rod to many in the UK today who fear the consequences of uncontrolled immigration. The future economic ties between the UK and the EU will eventually turn on how much compromise each side is willing to make on these issues of sovereignty and immigration. In economic terms however, such issues are benign. What will be important is what level of restriction may apply to the trading arrangements between these two large economies as a result of these negotiations. Starting from the enviable position of operating within a free trading bloc, any new arrangements seem bound to include new trading restrictions and thus to be economically harmful to all sides.

Outside of a particularly nasty separation however, this economic self-harm should largely be contained to Europe. This is why, after initially selling off, global equity markets outside of Europe have now recovered most of their lost ground. To see how the market is viewing the current situation we need only to look at the difference between the FTSE 100 index, the main stock market index in the UK covering its 100 largest companies, and the FTSE 250 index, an index of the next 250 largest companies listed on the London stock exchange. The former represents some of the largest multinational companies in the world, companies with global operations and limited ties to the UK economy. Since the referendum result this index is now up 3.8%, an increase in large part driven by the positive translation impact the fall in Sterling implies for overseas earnings. In contrast, the FTSE 250 index – an index more closely tied to the underlying health of the UK economy – has fallen 4.9%. The fall in the FTSE 250 mirrors the falls in the French and German share markets (4.3% and 4.7% respectively), while the 6.3% and 9.5% falls in the Spanish and Italian share markets shine a worrying light on the economic impact Brexit may have on the more troubled parts of the Eurozone.

Away from the markets, the dust is also starting to settle in the political arena. It is telling that those with the most to lose from the UK exiting the EU are those who have been the most vocal about the need for the UK to swiftly invoke article 50, a process that starts a two year timetable for a country to leave the union. 2017 sees government elections in France, Germany and the Netherlands and these elections come at a time when support for the EU is at an all-time low in most countries. A recent Pew Research survey showed that while the British public has a net unfavourable view of the EU of minus 4%, this is dwarfed by the net minus 23% rating recorded by the French. It is also not substantially different to the net positive 2% and 5% responses recorded in Germany and the Netherlands respectively. President Hollande of France was one of the earliest and most vocal figures calling for the UK to invoke article 50 and leave, hinting strongly of hefty repercussions for the UK in the coming trade negotiations. With approval ratings of just 17% (President Bush’s all-time low was only 25%), and facing the National Front in the coming election who will be running on an anti-EU platform, nothing would aid Hollande more than headlines of his administration teaching the British an economic lesson. Possibly more worryingly for the European Project, in the Netherlands polling shows that the Party for Freedom (PVV), an anti-immigration and anti-EU party, has a commanding lead over both the centre left and centre right mainstream parties. While PVV might be kept out of government by these two parties forming a coalition, the prospects of “Dexit and “Frexit” will hang heavy over the coming Dutch and French elections, scheduled for March and April next year respectively.

In economic terms it will be in all countries best interests to negotiate the most open and mutually beneficial trade deal that is possible in these coming negotiations. In the EU however, this position will be overshadowed by the political fears of many of the federalists in Brussels, who will be highly sensitive to the precedent set at a time of waning EU popularity. The stark truth today is that if similar referendums were held in other EU member states, it is quite likely that more exits would result. Thus, the longer “Brexit” hangs over European politics, the more risk that further referendums are called. This situation is not lost on those in government in the UK, where in the face of punitive EU politicking, the UK’s best interests will be served by seeing these negations take as long as possible. Theresa May, the most likely new PM in the UK, has already said that she does not believe there is a deadline to invoke article 50, and that such action should only be taken once the UK has established the best negotiating position for itself.

We should expect much jockeying and positioning in the coming negotiations, but short of a great blunder by either side, the impact from Brexit should largely be contained to that of a drawn out European trade dispute. Hopefully one where economic sense is what finally prevails.