A lame-duck prime minister; a (so far) silent chancellor; an opposition party in turmoil; a possible general election in the autumn that could produce a hung parliament; and the threat of a second referendum in Scotland. Do not be surprised if financial markets take a second look at Brexit and decide that Friday’s initial response was too tame.
The $2tn (£1.5tn) of stockmarket value removed around the world is a large figure, of course. But the reaction wasn’t as dramatic as some had feared – the FTSE 100 index ended the week higher than it started, for example. Investors may think again. They already knew that the old image of the UK political landscape – basically stable and predictable, at least by comparison with most of Europe – had suffered a jolt. But they may not have been prepared for the size of the earthquake. Expect aftershocks.
Fund managers – or, at least, those who take a long view – have tended to make two points about Brexit. First, that the exact terms of the UK’s exit will be the important thing. Yes, a short-term economic hiccup – even a mild recession – would be possible but proper judgments could only be made when the UK and EU get down to hard bargaining.
On that score, it was encouraging that German chancellor Angela Merkel, in contrast to many EU leaders, said she would not press for a quickie divorce. Her cautious tone carried a pleasing hint (for markets) that mutually beneficial commercial interests would be uppermost in the coming talks and that the German business establishment had reminded Berlin that the country has a substantial trade surplus with the UK.
But fund managers’ second point about the post-Brexit world was this: the UK government had to enter the talks with a clear idea of what it wanted. The moment to worry would be if the UK leave camp started to squabble within itself. On that front, the events of the weekend look alarming. The Brexiters have won the referendum but seem to have little idea of what to do after victory.
Do they want access to the EU single market or not? We have heard endless claims that the UK, armed with a bigger economy and greater negotiating clout, can secure a better deal than Switzerland, Norway or Canada. But nobody has agreed what this model might be. A degree of vagueness was inevitable, but there is a world of difference between constructive ambiguity and not having any concrete negotiating principles.
In the City, they can see the threats close up. London is the current financial capital of Europe, but now Britain’s Jonathan Hill is no longer the commissioner in charge of financial services. On his way out, Hill has warned the City to prepare for an era in which the French and Germans write the financial rules.
Would the UK government, whatever its makeup, be prepared to accept that outcome if it can secure tariff-free access to EU markets for, say, the country’s carmakers? Nobody knows, but the toe-to-toe negotiations could come down to such hard choices, all of which carry heavy implications for the Treasury’s tax revenues.
It is possible to take the opposite view. The democratic process always carries the risk of shocks but it usually resolves crises eventually. Maybe the big losers in Friday’s stock market shakeout – the big banks and housebuilders – were over-sold. The banks are better capitalised these days and the Bank of England, at least, seems to have done its thinking about Brexit in advance. As for houses, the UK will still need to build them, and a government of any colour may still wave financial incentives. Share prices in those corners of the market could bounce.
But watch sterling, which is a better gauge of how international investors view the UK’s prospects. Friday’s 8% fall against the dollar was sharp but, versus some expectations, not severe. At $1.37, it still well above the eye-catching predictions that $1.20 lies in store. Mark Carney at the Bank will also be watching closely, one suspects. The exchange rate will strongly influence the UK’s short-term inflation outlook. The Bank can only start to think sensibly about interest rates and other policy responses when sterling starts to stabilise.
