Brexit – What Now?
The UK electorate confounded the bookmakers last week voting ‘Leave’ in the referendum on EU membership, leaving political analysts and financial markets wondering what happens next.
The long-term impact of the vote on the UK economy and the knock-on effects internationally will ultimately depend on the relationship the UK ends up having with the EU – there is a spectrum as to what this could be: from a restrictive relationship with constraints on movements of people and tariffs on trade, to a benign relationship akin to the Norwegian model (and even the possibility that the UK still does not leave the EU cannot be entirely ruled out at this stage).
However, the current issue is that in the absence of clear political leadership in the UK there is uncertainty as to what the UK wants this relationship to be and how it will engage with the EU to agree that. The uncertainty is exacerbated by the disunity within the UK – both of the main political parties are divided, there were conflicting regional votes and there are divisions among the general population. This leadership vacuum is unlikely to be resolved at least until after the Tory leadership contest which is not expected to be concluded before September.
In the meantime uncertainty will be to the fore. UK businesses and individuals are expected to defer investment decisions and the consumer is likely to be more cautious. While the UK may bear the brunt of this there will be some spill over internationally. For the UK a period of economic contraction in the near term is now highly probable while global growth is likely to be lower than previously expected.
We would expect that central banks will take supportive action to mitigate the impact of this uncertainty. Further policy easing by the Bank of England is expected (maybe in the form of lower interest rates and a restart of Quantitative Easing) and some action by the ECB is also possible. Elsewhere, decisions on when to raise interest rates in countries such as the US and China are likely to be delayed.
Financial markets had a significant initial reaction to the referendum result – sterling and equities fell, although there has been some recovery in recent days. The period of uncertainty ahead is unlikely to be friendly to financial markets particularly as negative newsflow on economic and business activity is announced. However, some would argue that a lot of the uncertainties have already been priced in and central bank policy moves may provide some reassurance. The only strong likelihood is that markets are likely to remain volatile until clarity emerges on how the UK’s relationship with the EU is likely to evolve.
We remain focused on building long-term returns without taking undue risks and we remain alert to taking advantage of bouts of volatility to build our positions in high quality assets at sensible valuations.
(Our unit funds are next priced on July 1st and our July monitor will update on how our investment strategies have performed post the Brexit vote).