Where is it? What happened to the pain that was predicted by the economics profession if a majority of the public voted for Brexit?
Shares in the UK’s biggest companies are now worth more than they were before the vote. Against the euro, the value of sterling is, we’re informed by Boris Johnson, no lower than it was three years ago. There has been no plague of frogs. The sky has not fallen in. Life seems to be carrying on more or less as normal, doesn’t it? So was it all scaremongering? If you are inclined to think along these lines, to conclude that “the experts” all got it hopelessly wrong, think again.
The fact is that there has already been a significant impact on financial markets from last week’s referendum result – and these movements will, in time, have a negative impact on people’s living standards and economic opportunities. Yet the channels for those impacts are not necessarily immediately obvious to people, so it is worth spelling them out.
First, the currency. Be in no doubt that the value of the pound has moved a lot. Indeed, sterling has shifted more, in a shorter space of time, than at any point since the major currencies of the world were allowed to float freely against each beginning in the early 1970s. And the direction of the pound against other currencies has been uniformly down. Against the dollar, sterling is now at its weakest since 1986. The pound is also sharply lower against the euro. It is feebler against just about every other currency under the sun, from the Thai bhat to the Australian dollar. That means it has become more expensive for Britons to buy holidays abroad. Foreign imports have also instantly become more expensive. People will soon start to notice that price effect in the shops.
True, against the euro, sterling is only down at October 2013 levels. Yet it would be unwise to take too much reassurance from this given the euro has itself been hammered in recent years because of the single currency’s existential crisis.
Our exporters will now find their goods more competitively priced on world markets, which might help boost their sales overseas. It will also be cheaper for foreign tourists to come to the UK, which might boost the hospitality industry. But will these benefits outweigh the overall economic costs to the UK of such a sharp sterling depreciation?
It the world economy was booming that might have happened. But that’s not the state of the world today and the judgement of most economists is that the UK will be a net loser.
What about shares? Despite an initial fall, the FTSE 100 of blue chip UK-listed shares is higher now than it was on 23 June. But this is an index chock full of multinational companies such as the oil giant BP, the global bank HSBC and the international commodities trader Glencore. Around three quarters of the revenues of FTSE100 companies come from outside the UK. Because these companies report their profits in sterling, the pound’s depreciation boosts the nominal value of those reported profits, giving an automatic lift to their sterling share prices.
The FTSE 250, which is made up of smaller companies that predominantly generate their revenues in the UK, is down around 10 per cent since the vote. This is a much better indication of financial traders’ expectations of how the referendum result will ultimately affect UK companies’ profits.
Note too that individual shares and sectors on the FTSE 100 have taken a severe pounding, even though the index overall is up. The major banks Lloyds and the Royal Bank of Scotland, in which the UK taxpayer still has a large stake thanks to the 2009 rescue, have tanked. The state’s paper loss due to the falls in the values of these two institutions since the 23 June plebiscite is around £8bn – equivalent to £125 for every person in the country.
Perhaps the most unintuitive channel of post-vote pain is the rise in the price of UK government bonds. In times of financial stress, investors tend to sell riskier assets such as shares and rush to perceived “safe havens” such as gold and government bonds. This includes UK bonds, known as gilts.
When the price of these gilts rises, the interest rate on them, known as the yield, automatically falls. And 10-year gilt yields since the referendum vote (which were already close to all-time lows) have now plunged below 1 per cent.
This fall in gilt yields means the Government can borrow very cheaply for a relatively long time, which can be a benefit so long as the government uses that flexibility to invest in new infrastructure. But a gilt yield collapse also has the malign knock-on effect of inflating the liabilities of companies with defined-benefit pension schemes.
Actuaries estimate that, since the referendum, the combined deficit of UK schemes has jumped to £935bn, £25bn worse than ever before. This is likely to put pressure on the dividends that many companies are able to pay to shareholders. It will also crimp the ability of firms to increase wages and hire more workers.
Several big corporate investment projects are in doubt in the wake of the referendum vote. A government decision on a new Heathrow runway has been pushed back yet again. Scepticism swirls over the proposed new high speed rail line to the north of England and a new nuclear power station at Hinkely Point in Somerset. There are also signs that house building and commercial property construction has ground to a halt. Because investment is an important component of GDP, a new recession, or at very least a severe growth slowdown, is expected by most economists.
Policymakers are not sitting on their hands in the face of these recessionary forces. The Chancellor, George Osborne, has said the government will not seek to cut more from public services as tax revenues fall short, meaning that fiscal policy will not, mercifully, be making the economy still worse.
And the Bank of England’s Governor, Mark Carney, has signalled a short-term interest rate cut is likely over the next two months to prop up domestic spending. That could mean a reduction in families’ monthly mortgage interest payments.
Yet there are nasty side-effects here too. If the Bank of England base rate is cut to a new historic low of 0.25 per cent, that would also imply another reduction in the interest paid on people’s cash savings in banks. Bear in mind that elderly savers were already howling about their rock bottom savings returns.
But the biggest source of economic punishment in the wake of the referendum is actually time. The imminent departure of David Cameron as Prime Minister means there is no clarity about what sort of trade relationship the UK will now seek to establish with the rest of the European Union, let alone the sort of relationship we might be able to secure from our disgruntled former partners.
The longer that fundamental uncertainty persists, the longer business investment will be deferred, the more pressure will be applied on share prices and the greater the ultimate damage inflicted on the economy and living standards will be.
As with certain unfortunate cartoon characters, when economies run over cliffs it can sometimes take some time for gravity to kick in. The post-Brexit vote cliff is real. The only uncertainty concerns the size of the drop.
Join our new commenting forum
Join thought-provoking conversations, follow other Independent readers and see their replies