Since the EU referendum on 23 June, Brexit has dominated news headlines. This is understandable since it’s the biggest political and economic change the UK will experience in a generation. While in the short run there could be a degree of uncertainty, in the long run Brexit may not hurt the UK economy by as much as expected.
Of course, in the last few months, the impact of Brexit has been rather mixed. On the one hand, the pound has weakened severely against the dollar. It’s now trading at £1/$1.27, which is the lowest in over a decade. This is reflective of the uncertainty the UK economy faces as its future in a post-Brexit world is unclear.
However, the weaker pound is also due to an interest rate cut by the Bank of England after the referendum. US interest rates are forecast to rise in the coming months, so there are more forces at work regarding the weaker pound than just Brexit.
The Bank of England predicts that unemployment will rise to 5.5% over the medium term and that UK economic growth will be lacklustre in 2017. This would be a direct impact of Brexit and a weaker pound could cause inflation to rise in 2017 and beyond. That’s because imports will become increasingly expensive in sterling terms, which could push up the prices of consumer staples such as food and clothing.
A weaker pound could help the UK economy, though, because it will make UK exporters more competitive. This could lead to higher profitability or more sales than if the pound was stronger. As such, the effects of Brexit are still very difficult to accurately predict.
Hard Brexit?
Of course, the impact of Brexit on the UK economy will depend to a large extent on the agreements made between the UK and the EU. The British government has not yet invoked article 50 of the Lisbon treaty and so we must wait for news on how talks are progressing. What seems increasingly likely following the Conservative party conference is that a ‘hard’ Brexit is very much on the table. This means that the UK may not adopt a Norwegian or similar model in future, but rather would truly go it alone as an independent state.
In terms of the FTSE 100, its performance has been aided since 23 June by a weaker pound. As uncertainty builds regarding the UK’s economic outlook and UK interest rates remain low, it would be unsurprising for the FTSE 100 to continue the gains that have seen it trade 12% higher than the day before the referendum. But with the FTSE 100 being international, it’s perhaps not the best indicator of the state of the UK economy.
So, over three months after the EU referendum, the effect of Brexit on the UK economy has been mixed. While uncertainty is likely to remain high and business confidence could come under pressure, a dovish Bank of England should help to keep the UK’s economic growth upbeat. As such, the long-term impact of Brexit may not be all that bad.