Uncertainty and Implications of BREXIT
On Uncertainty and Implications of BREXIT, the Centre for Economic Performance (2016) points out that since the United Kingdom’s referendum to withdraw from the European Union, predominantly referred to as ‘Brexit,’ standard measures have pointed toward a substantial rise in uncertainty. Bloom (2009) describes uncertainty as the incapability of economic agents, for instance, investors, politicians, or consumers, to develop clear expectations as regards forthcoming economic developments. Accordingly, in the context of the United Kingdom’s vote to leave the EU, there is considerable uncertainty concerning the future arrangement of trade relationships after Brexit has been effected. As such, Schwab (2016) states that the financial consequences of the UK’s ‘leave ‘vote are being experienced already. These effects will likely increase once Article 50 of the Lisbon Treaty is implemented. The Lisbon Treaty handles the withdrawal of a member state from the EU (Schwab, 2016). Also, the Bank of England (2016) notes that due to Brexit, there is a material slump in the prices of certain euro-area risky assets, for instance, bank equities, where concerns regarding the profitability of some banks in the euro region aggravate the fall in prices. Besides, slower growth in the UK, as viewed by the Bank of England (2016), could also weigh on export growth in the euro region to some extent. Accordingly, this paper analyses the uncertainty and implications of Brexit for the United Kingdom and the European Union.
The Uncertainty and Implications of Brexit to the UK and EU
The European Commission (2016) notes that the referendum’s results to leave the EU on the twenty-third of June 2016 have altered the settings for the way ahead. For instance, the vote to withdraw from the EU has caused a considerable increase in uncertainty, sudden exchange rate fluctuations, and financial market instability. Furthermore, Breinlich et al. (2016) assert that the developments instigated by Brexit, including the rising uncertainty brought about by what is likely to be a prolonged period of withdrawal from the EU negotiations, can damage the recovery in the European Union. Even so, the European Commission (2016) suggests that while uncertainty is anticipated to fade away, future political and economic changes between the United Kingdom and EU Member States might have an enduring effect on the medium to the stable economic outlook. Currently, the economic outlook, according to Fichtner et al. (2016) and the European Commission (2016), is chiefly influenced by the uncertainty due to the United Kingdom’s vote of withdrawal from the EU. Hence, without clear information regarding the circumstances after the implementation of Brexit, for instance, policy responses, the mobility of products, labor, and services, as well as trade patterns, it is hard to outline the ‘new equilibrium’; and as such, it is difficult to specify the adjustment path. Therefore, according to the European Commission (2016), the uncertainty shock might differ in duration and dimension.
Also, as noted by the Bank of England (2016), the sterling ERI (Exchange Rate Index) has slumped by nine percent since the ‘leave’ vote on the twenty-third of June 2016, as shown in figure 1 below; and by fifteen percent since its peak in November 2015, having declined against both the US dollar and the euro. As such, the Bank of England (2016) reasons that, in part, this could point to concerns that, depending on the results of any upcoming negotiations, withdrawing from the EU can reduce the competitiveness of the UK. Nevertheless, there remains considerable uncertainty regarding the type of the UK’s forthcoming trading engagements and the implications for competitiveness. As viewed by Walduck (2016) and the Bank of England (2016), this has the probability of increasing the risk premium investors need to hold sterling-denominated assets.
Figure 1: The Sharp Fall of the Sterling Exchange Rate after the Referendum
Source: Adapted from Bank of England (2016)
Following Brexit, the exchange rate has sharply dropped, as shown in figure 1 above, and as such, the outlook for growth in the short-to-medium term has deteriorated significantly. Accordingly, the plunge in the UK’s sterling pound will likely increase CPI (Consumer Price Index) inflation in the near term (Bank of England, 2016; Acs, Szerb & Autio, 2016). The World Economic Forum (2016) explains that in the actual economy, even though the unconvincing medium-term outlook for an activity to a great extent is a sign of a downward review of the supply capacity of the economy, imminent weakness in demand has the probability of opening up a margin of spare capacity, together with a subsequent upsurge in unemployment. In line with this, the Bank of England (2016) asserts that the latest surveys of trade activity, optimism, and confidence point to the likelihood of the UK realizing minimal growth in GDP (Gross Domestic Product) in the second half of 2016.
Nevertheless, the European Commission (2016) states that in the case of moderate uncertainty concerning Brexit, the vote inhibits the economy’s growth for a limited period. On the other side, a more bleak uncertainty shock would intensify the risk premium and hence financing costs; and, as such, encourage households to consider precautionary savings (Centre for Economic Performance, 2016; European Commission, 2016). Also, due to Brexit, other EU Member States are directly affected by the depreciating sterling pound and reduced demand for products and services in the United Kingdom, reducing their exports. In addition, Dhingra et al. (2016) and European Commission (2016) suggest that the uncertainty is also likely to affect consumption and investment in the rest of the European Union, although to a smaller level than in the UK.
Therefore, although the effects of Brexit on non-European Union economies are hard to deduce at the moment, the significant impact is likely the broad-based growth in economic and political uncertainty, increasing risk aversion, and a resultant flight to safety. As such, this could amplify upward pressures on currencies considered to be ‘haven’ (for instance, CHF, USD, JPY), as well as weighing on business confidence and exports in several developed economies such as Switzerland, Japan, and the USA (Morgan. 2016; European Commission, 2016; Begg & Mushövel, 2016; Busch & Matthes, 2016). Hence, Brexit is likely to affect the United Kingdom and the rest of the European Union economy through various transmission channels, primarily trade, uncertainty, migration, and investment. Overall, the heightened uncertainty in the United Kingdom and other EU Member States will likely slow down investment decisions either by causing their cancellation or delaying them while waiting for uncertainty to diminish (European Commission, 2016). Also, the Bank of England (2016) states that it has been proven that increasing uncertainty about Brexit is causing delays to critical economic decisions that are turning out to be costly and will be challenging to reverse, including residential as well as commercial real estate businesses, and also trade investment. Therefore, situation examination and determination of uncertainty shocks of various severities reveal a decline in investment growth already in 2016 and could worsen in 2017. According to the European Commission (2016), these implications could be made worse should the uncertainty shock affect the financial system harshly and result in more arduous credit supply conditions. In addition, based on the duration and magnitude of the uncertainty shock, the effect on investment might bring about a recession in the United Kingdom (Busch & Matthes, 2016; European Commission, 2016; Dhingra et al., 2016).
However, the Bank of England (2016) states that the MPC (Monetary Policy Committee) has deliberated on various monetary policy devices and the support each one should provide to the United Kingdom economy, especially businesses and households. The MPC is mandated to support the economic policy of the UK government, together with its objectives for employment and growth. Accordingly, the Bank of England (2016) notes that in an environment of increased uncertainty, as well as low-interest rates, making use of a variety of tools would grow the effectiveness and also the efficiency of the monetary transmission mechanism, mitigating any uncertainty as regards the supply, together with the price of credit. Moreover, it would reduce its cost and improve supply. Furthermore, according to ECB (2011), heightened uncertainty can directly impact consumption by encouraging families to raise their precautionary savings and postpone purchases. This pattern has been noted during previous times of growing uncertainty. For example, during the sovereign debt crunch, consumers were unwilling to increase spending or make major purchases (ECB, 2011). In addition, Balta, Valdés-Fernández & Ruscher (2013) claim that increased uncertainty can also impact consumption indirectly through its negative effect on employment creation and economic growth, which would bring down the growth of disposable incomes more than they reduce inflation. As such, the growth of household consumption is thus expected to be lowered. Nonetheless, while the direction of these short-term impacts is known, the magnitude of the effect depends on the size and length of the uncertainty shock (Balta, Valdés-Fernández & Ruscher, 2013).
Even so, as stated by European Commission (2016), despite the uncertainty caused by Brexit, the past good record of employment growth, high levels of consumer confidence, and increasing wages still moderate inflation rates. Anderton et al. (2014) assert that employment in the United Kingdom has also profited from structural reforms effected after recovery from the global financial crisis of 2008. Additionally, in some EU Member States, for instance, the UK, temporary fiscal measures appear to have supported employment growth. However, according to the Bank of England (2016), the increased uncertainty due to Brexit is expected to weigh on the United Kingdom’s domestic demand growth. Accordingly, trade links could lower activity growth elsewhere, for instance, in the rest of the European Union and the USA. As such, the Bank of England (2016) explains that these developments could only, to some extent, be offset by the support to spending growth from drops in the United Kingdom, the European Union, and the USA regions.
To summarise, it has been noted that since the United Kingdom’s referendum to withdraw from the European Union, standard measures indicate a substantial increase in uncertainty. Moreover, it has been stated that Brexit has a high probability of affecting the United Kingdom and the rest of the EU economy through various transmission channels, for instance, uncertainty, trade, investment, and migration. In addition, it is evident that in the near term, the significant effect of Brexit is heightened political and economic uncertainty. Accordingly, these issues will likely slow investment growth and private consumption and affect foreign trade, primarily in the United Kingdom, even though other EU Member States are also likely to be adversely affected by Brexit. Also, Brexit has caused unexpected exchange rate fluctuations and financial market instability. As such, the depreciation of the sterling pound will likely push up CPI inflation in the near term. Additionally, depending on the outcomes of any forthcoming negotiations, Brexit can plummet the United Kingdom’s competitiveness. The depreciating sterling pound directly affects the EU Member States through lowered demand for products and services, reducing exports. Furthermore, based on the intensity and length of the uncertainty shock, the impact on investment may result in a recession in the UK. Besides, the heightened uncertainty can also influence consumption indirectly through its negative impact on employment creation and economic growth, which might reduce the growth of disposable incomes and encourage families to increase their precautionary savings and suspend purchases. Finally, despite the uncertainty brought about by Brexit, the previous commendable record of employment growth, improved consumer confidence, and rising wages still moderate inflation rates in the United Kingdom.
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