Against expectations, the final outcome of the referendum on 23 June on whether Britain should remain in the European Union resulted in the “leave” vote obtaining 51.9%. What does this mean for global economies?
The initial market reaction to the outcome was decidedly negative with the British Pound dropping to a 32-year low against the US dollar on the day. UK banks, real estate and retailers were under severe pressure, recording double digit losses during the day.
As expected, safe haven assets such as US government bonds, the US dollar, Japanese Yen, Swiss Franc and gold were immediate beneficiaries, and it is likely to continue to benefit during this period of elevated uncertainty.
Somewhat surprising was the strong flow of capital to emerging markets, where risk aversion spiked less than anticipated. Higher yields on offer seem increasingly attractive against the expectations for continued easy monetary policy in the developed world.
Economic impact
The UK economy represents less than 5% of global GDP and the impact on world economic growth is expected to be limited. The short-term impact on the UK economy will be more pronounced.
Uncertainty is the enemy of the UK economy for the next few years. It is not so much the event itself, but rather the political and economic uncertainty during this transitioning phase that will impact on consumer and business confidence and hence economic activity. There is a strong possibility that the UK could enter a short-term recession or a period of no growth.
Consumer inflation is likely to increase on the back of the weaker currency, while the Bank of England will be hesitant to raise interest rates during this uncertain period. The rapid pace of the pickup in tourist activity, in the past few months thanks to a weaker currency, has been somewhat unexpected but will provide a boost to GDP.
Exports to the UK comprise a small portion of South Africa’s total exports, while the larger European Union is one of SA’s largest trading partners. Brexit will create uncertainty around the future of SA’s trade agreements with the UK and EU and could put net exports (resulting in lower GDP) and the current account (deficit increase and weaker currency) at risk.
The road forward
The UK will likely remain inside the EU for at least two years, and possibly even longer, as the UK irons out its future trading relationship with the remainder of the EU and the rest of the world.
Article 50 is yet to be formally triggered by the UK. Initial estimates were for this to happen towards the end of 2016, but PredictWise currently indicates that there is a very low probability that it will happen in 2016, with equal probabilities for the first half of 2017 and the second half of 2017 or later.
Momentum Investments economist, Sanisha Packirisamy, stated that the Brexit vote has raised alarm bells over the growing calls for referendums to be held in other EU member countries. Political risk will play a major role in preventing a sharper acceleration in growth in the EU region in upcoming quarters and will suppress price pressures further.
Portfolio positioning
Perhaps, the biggest lesson learnt from this event is that in a post Global Financial Crisis world, where many people feel that the current system is not working for them, political risk is high and mostly unforecastable.
Mistakes in investments most often happen when investors react hastily to new information and temporary shocks. Having a diversified portfolio suited to a client’s needs, mitigates the need to react. Financial advisers need to ensure that their clients’ investment portfolios are suitably diversified, with a prudent balance of asset exposures. Positioning portfolios for a specific event is a high risk strategy in the current political and economic environment.
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