Votes are in and Britain has voted to leave the European Union. With a respectable turnout of 72.2%, Brexit has become a reality as Brits voted 51.9% against 48.1% in favour of the Leave camp.
Frenzy ensued in the currency market as the pound faced deep depreciation of 11.7% hitting a record 31-year low as of 27th June 2016.
With high levels of uncertainty, investors rushed to safe haven assets such as yen and gold, which appreciated by 7.2% and 8.1% respectively.
The announcement of the referendum result is set to result in a prolonged risk-off period as it is set to paint a gloomy investment and economic environment in the UK and the world.
Spillover Effects from Currency
The continuing depreciation of the pound will directly affect business operations as well as the daily lives of British citizens. Prices will increase significantly, reducing the purchasing power of the locals as prices of goods such as energy and fuel are set to be greatly affected.
With high inflationary pressure, a double whammy effect is set to hit the UK economy as trade is expected to face declining pressure from the referendum as well.
A Stage for Declining Trade and Employment
In the short run, business and consumer confidence are expected to face setbacks. With the Brexit in place, the UK government will have to renegotiate all of its trade agreements.
Negotiations are expected to be tedious and arduous given that consensus will have to be reached by UK and the 27 EU nations. As a result, there is increasing risk that businesses in UK may no longer have a gateway to the open European market, setting the stage for high tariff barriers that will ultimately squeeze businesses’ margins.
In light of such circumstances, investors’ confidence in UK businesses have also taken a hit, evident from the sharp decline faced in stock markets such as with the FTSE 100.
Instead, investors are flocking into the bonds market due to the perceived safety of this asset class.
In tandem with slowing investment inflow for businesses, consumers are expected to feel that pinch as well. As investors flee from the UK economy, businesses will be expected to face a drop in profit, ultimately leading to higher level of unemployment and wages.
If all these conditions play out, they will have adverse effects on the UK’s GDP growth, which may ultimately prompt an intervention from the Bank of England to spur growth in the economy.
Precedence for Further Exits
The UK is the first country to have voted to leave the European Union since its formation. Previously, membership into the EU was deemed irreversible as no member country had ever left.
With economies such as Italy and Spain suffering from the Euro’s lack of strength as well as countries becoming increasingly unhappy with the immigration issue in the EU, Brexit may have signalled the beginning of EU’s fall, bringing with it an entire wave of change in the global economy.
The tide of EU integration may shift as countries may be more willing to hold their own referendums, especially if the UK becomes successful as a standalone country outside of the EU.
With Brexit being all but finalised, only time will tell whether the decision to leave is a good or bad one. In the long run, the UK may benefit from being out of the EU, given its freedom to negotiate trade deals and policy autonomy that comes with Brexit.
With the resignation of Prime Minister David Cameron, the months following Brexit will be crucial. There will be a contest for new leadership, and this leadership will ultimately set the tone for and be vital to the UK’s survival outside the EU.