So, the opinion polls, which had shown a big move towards a Remain vote, got it wrong yet again, with Leave squeaking a win by 51.9% to 48.1%.
Market reaction has been predicable, inevitable and damaging. Sterling, having briefly hit $/£1.50 has plunged, hitting its lowest level in 30 years against the dollar, lining it up for its largest single-day drop on record. Equities in Asia have fallen sharply, with European and US equity markets set to follow suit when they open. The yen has surged, while the euro has got caught up in the back draft, dropping 4 cents against the dollar. Yields on most major Government bond yields have plunged, although euro area peripheral bonds are under pressure.
That’s the short-term impact. Longer term, this vote will have all sorts of consequences. First, the UK economy. The Leave side have spent the whole campaign rubbishing the claims of just about every single reputable economist and economic institution that a vote for Brexit would have negative short and long-term consequences on the UK economy. The experts, they claimed, know nothing. Well, unfortunately, we’re now going to find out. And the experts are going to be proved right. The UK will now do well to avoid recession as the uncertainty about its future relationship with what is by far its largest trading partner hangs in the balance for years, and possibly a decade or more. At the very least, a significant slowdown in growth is coming in the near term. And while inflation will be boosted by the drop in sterling, the Bank of England will look through that to try and support growth. A near-term rate cut and a re-launch of QE can be expected. And, ahead of that, the Bank will be looking to reassure markets that they stand foursquare behind the UK’s banking system, providing liquidity where required.
Other central banks may also need to spring into action. The spike in the yen is a massive unwanted headache for Japanese policymakers at a time when the economy is already floundering. If the yen’s strength persists, expect the BoJ to act via a further loosening in policy and/or MoF-sanctioned forex intervention. The ECB will also want to calm any market fears, while the Brexit vote gives the Fed yet another reason not to hike again, especially with political risk in the US set to rise as the Presidential election gets closer.
Looking further ahead, the negative economic shock will be further exacerbated by what is certain to be a period of continued political turmoil. While both sides have suggested that David Cameron should stay on as Prime Minister, it seems inconceivable that he will be able to and rumours are circulating that Boris Johnson and Michael Gove are negotiating his exit. He is likely to address the country later this morning and it may well be that he announces that he will step down then. Even if he doesn’t, it seems unlikely that he will hang around for long, triggering a Conservative party election contest.
Recession and political turmoil will be further exacerbated by what is almost certain to be new moves in Scotland to push for a second referendum on independence. The Scots voted overwhelmingly, 62:38 to remain in the EU and the fact that they could be dragged against their will along with the rest of the UK provides the perfect opportunity to have another vote on independence, this time presumably with the EU offering the possibility of continued membership. The risk of the break up of the UK will just add to political and economic uncertainty and, in particular, fears over the future of those large Scottish-based financial institutions.
Meanwhile, the other EU leaders will act entirely in their own interests, and will want to look to limit any boost that other anti-EU politicians get from the UK result. So, for example, they are likely to want to send a clear message that the UK will not be able to negotiate a special deal with the EU on trade – to do otherwise would merely to be to encourage other Leave movements. In particular, they will reiterate that full membership of the Single Market would require the UK to continue to pay its dues to the EU (meaning the £350mn per week the UK Leave campaign have falsely claimed the UK gives to the EU would not be available for the myriad things it has said it would spend it on instead) and accept free movement of people (breaking the Leave campaign’s most effective campaigning tactic, that leaving the EU would allow the UK to “control its borders”).
And this may well prove the future UK government’s ultimate downfall. Indeed, faced with reality, rather than rhetoric, and a realisation that the promises of the Leave campaign cannot be fulfilled without causing enormous economic damage, buyers’ remorse may well set in among the UK electorate. If so, that could well lead to pressure for a second referendum, and one that, once the Leave campaign’s shortcomings have been exposed, would likely see the UK turn volte face and end up not leaving. There are plenty of reasons to believe that the UK might not eventually leave the EU. But the journey from now on is going to be a painful one.
But all of that is for the future. For now, the focus for policymakers is to calm market fears and try and mitigate the impact on the economy. But yesterday’s vote does mean that political risk, traditionally one of the UK’s strengths, has now become a significant weakness. The continued existence of the UK in its current form is in serious doubt, while the threat of an early General Election may end up ever present. The coming months and possibly years certainly won’t be boring, but neither will they necessarily provide the sort of stable economic and political backdrop that has been a large part of the UK’s relative economic success over recent decades.