The five big financial signs to look out for after Brexit

How quickly the economic shock recovers depends on these factors

Hamish McRae
Sunday 26 June 2016 15:58 BST
A trader sits at his desk under the day's performance board that shows a dive in the value of the DAX index of companies at the Frankfurt Stock exchange the day after a majority of the British public voted for leaving the European Union
A trader sits at his desk under the day's performance board that shows a dive in the value of the DAX index of companies at the Frankfurt Stock exchange the day after a majority of the British public voted for leaving the European Union (Getty)

The first thing to look for this week will be the reaction of financial markets, a slightly more considered one than that on Panic Friday. The early signs are not encouraging, for the forward indicators of share prices show US, UK, and European equities all down. The projected decline in US share is actually larger than for UK ones, and on Friday the fall in Italian, Spanish and French shares was much greater than British. The big point here is that Brexit is seen as damaging the whole developed world economy, not just that of the UK, and Europe is very much in the firing line.

Bad bets or something more?

So the really interesting thing will be whether, as the week progresses, equity markets recover. There have been many shocks to the world economy over the past couple of decades, including 9/11, the second Iraq war, and the US housing crash. Markets have always reacted adversely, but eventually recovered. Eventually they will again. The question we will get more of an answer to this week will be whether the savage reaction to this shock was the result of most professional investors betting the wrong way, or something more fundamental. It is perfectly possible that by the end of the week both the pound and UK share prices will be climbing. But let’s see.

How weaker European countries fare

The second thing to look for on the markets will be what happens to the shares and bonds in the weaker European fringe countries. Ahead of the elections in Spain, investors were nervous there. If during the next few days peripheral EU members find their borrowing costs rising, this will show that the impact on the perceived durability of the eurozone and hence of the whole EU project.

Cracks that have been papered over may open up again. In practical terms the thing to look at will be the difference in the interest rate on German bonds, now negative, and that on those of Italy, Spain and Portugal. The more those spreads widen, the greater the pressure on the EU to create a deal that is acceptable to the UK – see point five. Thanks to having a flexible exchange rate, the UK can roll with the punches better than the weaker eurozone countries, which are locked into a rigid exchange rate.

Housing market indicators

Things to look for number three and four will help indicate the pressure for a deal in the UK. Three will be what happens to the UK housing market. There will not of course be figures showing the impact of Brexit on house prices. That will be months away. But the housing market will gum up. Transactions are likely to fall sharply, particularly in London, and that will unnerve people. The greater the disruption in the housing market, the greater the regret factor for leave voters.

What business leaders do - and what buyers buy

Four will be what companies say and do. Indeed you should pay much less attention to what business leaders say and much more to what they do. So all those statements about moving people out of the UK and cutting investment here have to be taken with a pinch of salt. Look also at what consumers do. Are people switching to British-built vehicles rather than French or German ones? These are early days but the power of the UK hand in any negotiation will lie on the one hand with the danger of businesses moving their business away, and on the other with the strength of the UK as a market.

An "associate status"

Finally, expect this week to hear a great deal more about the idea of the UK having some kind of associate status in the EU. There is a German government paper suggesting this as an option, and if attractive enough, this might enable the UK and EU to do a swift deal. Depending on the detail, this could either be presented to the electorate in a second referendum, or indeed attract enough general support not to need to go to the people again. There will be nothing hard of course in the next few days, but this is the most encouraging way forward and anything we can learn will be to the good.

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