Political turmoil follows the referendum result as it is clear that no-one really knows what will happen next. And that is not great for business and investor confidence
By Buttonwood
IT IS just 50 hours since the referendum result was announced. In that time, Britain’s prime minister has resigned, there has been a coup against the leader of the Labour party (still playing out as I write), sterling has had one of its biggest one-day falls in history, the banks are starting to talk about moving jobs to Europe, and Scotland has opened the process of calling a second independence referendum.
The political turmoil was predictable and predicted in this blog. Most MPs backed the Remain case and now have to implement the Leave case. Even the Leave campaigners are balking at invoking Article 50 immediately; David Cameron reversed his position and has left the decision to his successor. That means it won’t be until October. This can be presented as tactically shrewd; there is no rush. Although the rest of the EU is pushing Britain to act immediately, it would seem as if it can’t force the pace. But it also reflects the lack of clarity among those in the Leave campaign about what kind of deal they want; a Norway-style approach (with continued free movement and budget contributions) or complete separation (with restricted access to the single market).
Of course, this politicking only extends the period of uncertainty that will follow the referendum result. The nature of Britain’s trading relationship with the EU will not become clear until late 2018 at the earliest. All the more reason, then, for investors and businesses to delay any decision to put money into Britain; the potential economic damage is greater. Friday’s market moves saw a much bigger (7%) fall in the domestically-focused FTSE 250 than in the more multinational FTSE 100, which dropped 3%.
The problem for Britain is that it has a huge current account deficit, which needs financing from abroad. There is much talk about the way that a weaker sterling can boost exports, but it also raises the costs of imports (like oil) which will widen the deficit in the short term. Ian Harnett of Absolute Strategy Research says that
I remain convinced that the economics and politics of an isolated England leave UK assets and markets very exposed to the risk of a capital account induced recession...I am therefore very unhappy to confirm my view that in the coming months we will see sterling close to parity and UK equities, even with that fillip, 20% lower.
A weaker pound will also lead to higher inflation. Two things can happen in response. Either wages can rise in compensation, in which case business costs will rise and the competitive advantage of devaluation will be eroded. Or wages won’t rise and people's living standards will be eroded. So a Leave campaign fuelled by voter anger over squeezed living standards will result in a further squeeze in those living standards.
But will it happen? Ingenious arguments are being devised to find ways that withdrawal might be avoided after all; for example, thanks to devolution, some think that the Scottish government may have an effective veto. Your blogger overheard an earnest phone call yesterday saying that
Technically the vote is only advisory and Boris Johnson doesn’t really want to leave the EU. So they can fudge it.
Perhaps a new prime minister will call a general election to get a new mandate (what does it mean if it gets defeated?). Perhaps the terms of any exit deal would be put to the electorate in a second referendum (but what happens if that gets defeated?). Endless complications—chaos, in other words—lie ahead.
