If the British people have voted to leave the EU on Friday morning, David Cameron would seek to reassure the public when he addresses the nation outside 10 Downing Street. There would be much speculation about his future and that of the Conservative Party, but he would speak first about the result’s impact on the people.
He would probably emphasise that the process for leaving the EU set out in the treaty takes at least two years, and that very little will change during that time.
However, the pound would have been falling on the overnight exchanges. We have had a premonition of this whenever there have been opinion polls pointing towards a vote for Leave, such as ORB for The Independent on 10 June, which triggered a sharp fall in the value of the pound.
The markets think that Brexit would be bad for the economy, and so if a Leave vote looks likely investors would start to move their money out of the UK and the pound would fall. As soon as a Leave vote becomes definite, the pound would fall further to reflect fully that assessment of the future. But what would this mean more specifically?
More expensive foreign holidays
The Prime Minister would say that the Government stands ready to do whatever it takes to protect the British economy, but there are limits to what it could actually do. George Osborne’s threat to bring in an emergency Budget would probably be downplayed until the effects of the Brexit vote become clearer.
In the meantime it would be up to the Bank of England to intervene in the foreign exchange markets – by buying pounds – to try to stabilise its value.
So the first practical effect of a vote to Leave would be more expensive foreign holidays. The effect might be small, and it might even be temporary, but there is no question that the pound would go down.
No immediate change in immigration status
The Prime Minister would have to address other immediate concerns on Friday. He would be likely to reassure nationals of other EU countries living in the UK that their status is unchanged. That is what the Leave campaign has said, so, even after the Brexit negotiations are complete, those who are already in the UK would be allowed to stay.
As Jonathan Portes, the former Treasury economist, writes, “given we have no population register, and that EU nationals are not required to have visas, we won’t actually know who is here on 23 June”. Portes says the most likely arrangement is that suggested by Steven Woolf, UKIP’s migration spokesman, that anyone who’d registered for a National Insurance number before the referendum would be guaranteed residence rights.
For the two years of Brexit negotiations, free movement of EU workers would still apply, so people could still come from elsewhere in the EU, but their immigration status after Brexit would be uncertain.
A lower pound would mean that imports would become more expensive. This would mean the return of inflation – a phenomenon with which some young people may not be familiar. Prices have been stable for so long, rising at no more than about 2 per cent a year, that it might come as a shock to face the prospect of higher prices.
The effect would probably not be particularly noticeable in the first few months. At first price rises would be confined to imported goods – food and clothes being the most obvious – but inflation has a tendency to spread and to gain its own momentum.
Some economists may even welcome a small dose of inflation as a good thing, because it stimulates economic activity and prevents a slowdown in the economy turning into a slump or a Japanese-style long-term stagnation.
Interest rates might rise
The trouble with inflation is that the Bank of England has a legal obligation to keep it as close to 2 per cent a year as possible. If a fall in the pound threatens to push prices up faster than this, the Bank will raise interest rates.
This acts against inflation in three ways. First, it makes the pound more attractive, because deposits in pounds will earn higher interest. Second, it reduces demand by putting up the cost of borrowing, and especially by taking larger mortgage payments out of the economy. Third, it makes it more expensive for businesses to borrow to expand output.
Mark Carney, the Governor of the Bank of England, and his Monetary Policy Committee may face a dilemma. A few months after a Brexit vote, inflation may be rising and the economy may already be entering a recession. So, if interest rates do rise, they may not go up by much.
Did somebody say recession?
Mr Carney, the Treasury and a range of international economists have warned about this. Many Leave voters appear not to believe them, or to think that they are exaggerating small, long-term effects. But there is no doubt that a vote to Leave would act as a shock to the economy.
This is because it would change expectations about the economy’s future performance. Even though Britain would not actually be leaving the EU for at least two years, companies and investors would start to move money out of Britain, or scale back plans for expansion, because they would be less confident about what would happen after 2018.
This change in expectations and confidence could have quite a sharp effect on the economy, affecting investment decisions and jobs straight away – indeed there is evidence that the uncertainty about the referendum has already had an effect. That effect would be worse and would be irreversible if the result is a Leave vote.
And we wouldn’t even get our money back
All this would be happening while the Prime Minister, whoever he or she is, was negotiating the terms of our future access to the EU single market. In the meantime, our trade with the EU would be unaffected, except that companies elsewhere in the EU may be less interested in buying from us or selling to us, expecting tariff barriers to go up in two years’ time.
Whoever the Chancellor is, he or she may have to bring in a new Budget. George Osborne’s forecasts would be shot to pieces by the stalling of the economy, but it would probably be unwise to increase taxes or to cut spending in response.
And all that extra money that the Leave campaign claims would flow into the NHS and cheaper energy bills would not be available for some time. We would have to continue making our net contribution to EU funds – it’s about half what the Leave campaign says, but it is still half of one per cent of our national income – until the deal is done and we cease to be EU members.
Tomorrow Andrew Grice looks at what might happen in the year or two after Britain actually ceases to be a member of the EU, and on Wednesday John Rentoul tries to assess the long-term impact of Brexit
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