Riding out the storm: the economic implications of Brexit
June 24, 2016
The UK’s decision to leave the EU is the biggest political shock of my lifetime. It has already led to considerable volatility on financial markets and there will be a period of economic and business uncertainty as the details of our exit from the EU are worked out. As discussed in our earlier detailed analysis for the CBI, this is likely to depress business investment and growth for at least the next couple of years.
However, we need to keep these short term concerns in perspective. The Bank of England, working with the Treasury and other central banks, has already made clear it will do whatever is necessary to provide liquidity to the banking system and ensure financial stability. I would expect the MPC to consider additional measures to support confidence and growth over the coming weeks and months, possibly including a small cut in interest rates (but not going into negative territory), additional purchases of government and corporate bonds, and further credit easing through extension of the Funding for Lending Scheme.
The pound has fallen sharply in immediate response to the vote to Leave. This will increase import prices but will also help exporters, so it is not necessarily a bad thing so long as the decline does not go too far (and the Bank of England could step in if this seemed to be happening). Stock markets have also fallen, but these are always volatile and historical movements in the FTSE have not been closely linked to the growth of the real economy in the UK.
Looking ahead, the UK remains a highly flexible economy with many strengths in areas such as financial and business services, creative industries, tourism, higher education, and high value manufacturing. It would be in the mutual interest of the UK and the EU to agree a free trade agreement to cover goods and possibly also some areas of services, even if it takes some time to agree all the details. In the interim, the UK will remain in the EU and free trade will continue as before within the Single Market. For most UK companies, it will be business as usual.
We should also be able to agree similar arrangements with other key trading partners, including the US, in the longer term. Indeed, it could prove easier to do so when consensus across 28 EU countries is not required for such trade deals, which could open up many new opportunities for UK businesses with the fastest growing parts of the world economy.
Assuming such trade deals can be done, we estimated in our report for the CBI that in the best case scenario UK GDP by 2030 might be only around 1% lower than if we had remained in the EU – a small effect when considered against potential cumulative real GDP growth of around 30% over that period.
In summary, there is likely to be a short term shock to the UK economy, but we should be able to ride out the storm and continue to prosper in the long term.