The British people have voted to leave the EU. So what happens now? Later this morning Prime Minister David Cameron will address the nation outside 10 Downing Street. There is much speculation about his future, but he will probably seek first to reassure people.
He is likely 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 is already falling on the foreign exchange markets. The markets think that Brexit is bad for the economy, and so investors are likely to want to move their money out of the UK.
More expensive foreign holidays
The Prime Minister will probably 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 will be up to the Bank of England to intervene in the foreign exchange markets – by buying pounds – to try to stabilise its value.
The first practical effect of a vote to Leave, therefore, is that the pound will be worth less abroad, meaning foreign holidays will cost us more.
No immediate change in immigration status
The Prime Minister will have to address other immediate concerns. He is 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, wrote, “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 means that imports would become more expensive. This is likely to mean the return of inflation – a phenomenon with which many of us are unfamiliar because prices have been stable for so long, rising at no more than about 2 per cent a year.
The effect may 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. In a few months’ time, 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 have believed them, or to think that they are exaggerating small, long-term effects. But there is no doubt that the Leave vote is a negative shock to the economy.
This is because it changes expectations about the economy’s future performance. Even though Britain will not actually be leaving the EU for at least two years, companies and investors will start to move money out of Britain, or to scale back plans for expansion, because they are 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.
And we wouldn’t even get our money back
All this will be happening while the Prime Minister, whoever he or she is, is 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 feel the need to bring in a new Budget. George Osborne’s forecasts will soon 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. A July emergency Budget is unlikely. If adjustments have to be made, they can probably wait until the Autumn Statement.
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 have to continue paying our net contribution to EU funds – it’s about half what the Leave campaign said, 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.
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