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2016-06-29 08:58:10
Uncertainty abounds. Expect a global chilling effect on investment
Jun 24th 2016 | Business and finance
NIGEL FARAGE, the leader of the UK Independence Party, told elated supporters
that June 23rd should go down as Britain s Independence Day. The reaction in
financial markets to Britain s vote to leave the European Union was rather less
euphoric. During the Asian trading day, the pound plunged against the dollar by
over 10% to $1.32, a 30-year low. It fell far harder against the yen, a
frequent bolthole for the anxious. Investors have started to flock to the
safety of US Treasuries. As Europe s markets opened, the main stock indices
followed the lead set overnight in Asia and fell by around 10%.
Investors hate uncertainty and the result of the referendum gives rise to a
surfeit of it. But the falls in Asia s equity markets are also in large part an
early judgment about the impact on the world economy. Of course, markets often
overreact. Britain accounts for just 3.9% of the world s output; it is not big
enough to make the global economic weather in the way America or China can.
Then again, America s economy has been sluggish of late and there are grave
worries about China s ability to escape the shadow of its mountainous debts.
Britain s economy looms large in Europe, where it is a reliable consumer in an
otherwise high-saving continent. And any disruption to European growth is
particularly unwelcome now.
The Bank of England said this morning: We are well prepared for this. It may
cut its main interest rate from its present level, of 0.5%. It may even revive
its quantitative-easing programme, buying bonds with freshly minted electronic
money. A recession in Britain nevertheless seems likely. Corporate investment
will be hurt by uncertainty about future access to both the single market and
to other places where Britain has piggybacked on trade deals negotiated by the
EU. In unsettled times, businesses defer whatever spending they can.
The same is true for consumers. The majority who voted to leave the EU may
think that forecasts of recession in the event of a Brexit vote were a tactic
to scare voters. If so, they are unlikely to curb their spending overnight. But
as the bleak consequences for the economy become clearer, spending on
big-ticket items is likely to slump. The collapsing pound will drive up
inflation up, crimping real incomes. Some jobs will go. Hours worked and wage
growth will fall. And Britain is big enough for a recession there to have a
meaningful effect on Europe s economy. As a rule of thumb, whatever the
reduction in Britain s GDP growth, Europe s economy will suffer a drop of about
half as much.
Brexit will hurt the world economy in other ways. A big concern is the extent
to which a retreat from financial risk will disturb the existing fault lines in
the world economy, notably in China and southern Europe. Italy has a referendum
of its own (on constitutional change) in October. Matteo Renzi, Italy s
reform-minded prime minister, says he will resign if the result goes against
him. The Brexit vote scarcely helps his chances. A widening of bond spreads in
southern Europe seems likely in the run-up to the poll. The European Central
Bank can intervene to swamp the symptoms of anxiety by buying bonds, but it can
t do much more to cure the underlying problem of weak growth.
It is trickier to draw a line from Brexit to China. A weaker European economy
will certainly hurt Chinese exports. Perhaps a bigger risk is a renewed bout of
dollar strength, as Europe s currencies weaken, which might in turn put renewed
downward pressure on the yuan.
Even if some investors have short horizons, tumbling stockmarkets reflect some
long-term worries. If Britain, long a champion of free trade, can vote to
revoke a regional trade deal, how much faith can businesses worldwide put in
other international economic agreements? An EU shorn of Britain s deregulating
influence is a troubling portent for the liberal world order. Nationalist,
populist and protectionist forces in other countries will be greatly encouraged
by Brexit. The WTO recently gave warning that protectionist trade measures in
the G20 are multiplying at their fastest rate since 2008. In such
circumstances, it would be surprising if the Brexit vote did not have some
chilling effect on investment worldwide. It makes curbs on migration of workers
a little more likely, which will be costly for businesses. And if Europe
exports some of its misery to Asia and America through weaker currencies, it
may increase pressure for restrictions on capital flows, too.
A lot depends on the kind of trade deal Britain can negotiate with the EU and
how quickly. If Britain gets a quick deal with no big reductions in its access
to the single market, the grimmer scenarios for the world economy may not come
to pass. But markets do not seem to be counting on it.