When the British voted to leave the European Union last June, it was effectively a vote for sovereignty over wealth. Despite any promises by the ‘Leave’ campaign to the contrary, it was clear that Brexit would mean a hit to the UK economy. The question has always been when that hit would come and how much of a hit it would be – because that would decide if the trade-off was worth it.
I mention this because UK Chancellor Philip Hammond, who campaigned to remain in the EU, was at Mansion House today saying British people did not vote to become poorer, and that it was the government’s job to secure the best economic future it could. My view: While the second part of his statement makes sense, the first part doesn’t. Here’s why.
Outside of the EU, the UK will suffer losses due to tariff and non-tariff trade frictions – meaning an annual decline in growth relative to where it would have been. It is difficult to put a number on the loss but reasonable estimates are of a cumulative loss of more than five percent of GDP.
The ‘Leave’ position during the referendum was that the UK would pivot its trade relationships to the US, emerging markets and other countries (much as Germany has done with China and emerging markets post-sovereign debt crisis). But over a two- to five-year time horizon there will be pain.
Moreover, there’s the currency. Think of Brexit as a competitive currency devaluation that the likes of Italy and Spain never had as a part of the euro. The monetary and fiscal easing associated with this is a shot in the arm, yes. The economy will grow faster than it would without this natural adjustment. But it also means Britons are poorer. Currency depreciation means that UK assets are worth less and that UK incomes are lower relative to everyone else.
Conclusion: Brexit will have a limited economic impact on the UK because monetary and fiscal offsets would dampen the impact of trade frictions and the potential investment and consumption losses. That’s always been my view. But ‘dampen’ does not mean ‘eliminate’. A vote for Brexit was indeed a vote to become poorer.
Here’s my prediction: It’s easing. Now, it’s taken us a while to get here on the fiscal side but we have now arrived. As I wrote a year ago, just after the vote, “Brexit effectively means a weaker currency and a more dovish fiscal stance – competitive currency devaluation and stimulus, if you will. I see no other options because to not go this route would be a massive policy error that could lead to recession, forcing new elections.”
After trying their hand at austerity for nearly a year, Theresa May and Philip Hammond have indicated they now understand this logic. The BoE has always done. In fact, Mark Carney indicated today that – because of Brexit – the Bank of England’s monetary policy stance is looser than it might otherwise have been.
Outlook. Inflationary recession or oil respite. In the end though, the risk is an inflationary recession. For now, Mark Carney is resisting a rate hike. But how long will the Bank of England hold out? And how long can British consumers keep spending if real wages are falling? Two things would ease this pressure. One is some sort of fiscal support for real wages. But given the political sustainability of the UK’s deficit, that support will be limited. The second is the fall in oil prices, depressing inflation and easing the burden on wage earners.
As in the US, I see oil prices as key.
Post-script: None of this is an argument against Brexit, by the way. It is a recognition that voting to leave the EU in order to regain sovereignty over laws and migration has negative economic consequences.