Short term economic impact will be determined by ‘confidence’ - EY
UK economy faces an inevitable period of uncertainty, but trade, regulatory and fiscal levers will be available in the near-future that EU membership previously restricted or denied, says EY.
Martin Beck, senior economic advisor to the EY ITEM Club comments: “We are entering unchartered territory as there is no precedent for a member state leaving the EU and so there is little economic evidence to draw on. What we can be certain of however is that the response of UK policymakers may matter as much for the economy’s future well-being as the new relationship forged with the rest of the EU (REU).
“If the Prime Minister pushes the button on Article 50, we are unlikely to see any immediate changes in terms of the free movement of goods, services, capital and people between the UK and the REU. Article 50 sets out a negotiation period of up to two years.
“The short-term economic impact is more likely to come down to the effect on confidence and expectations. Uncertainty over the UK’s future trading relationship with the EU could continue to hold back investment in some industries. And there is a risk that firms in sectors where an EU domicile is important for business, notably international finance, may choose to move activity out of the UK to guard against the possibility of no deal being agreed. Capital inflows from abroad may also slow, triggering a potentially painful adjustment in the UK’s current account position, particularly if the vote precipitates a period of political uncertainty.
“However a fall in Sterling, which was widely predicted in the event of a ‘Leave’ vote and now appears to be in play, should help to cushion the economy against some of the adverse short term effects of Brexit, just as it did in 1992 when the UK left the ERM. If a weaker pound persists, inflation is likely to spike up in a year or so. But we think the Bank of England is likely to look through a temporary rise in inflation and support the economy via a loosening of monetary policy. The scope for the Bank to cut interest rates is limited, but a rate cut or additional asset purchases in August’s MPC meeting, which will also see the publication of the Bank’s first post-referendum forecast, is plausible.
“The UK economy will now face an inevitable period of uncertainty and upheaval. But trade, regulatory and fiscal levers will be available in the near-future that EU membership previously restricted or denied. The skill with which those levers are used will ultimately be what determines the longer term economic effects.”