The Impact of Brexit

On 24th June 2016 the majority of British citizens voted to leave the EU, and the shock that followed caused a major stir in the world’s financial markets. In order to understand the movements that are likely to occur in the economy in the aftermath of this unexpected decision, it is important to look economic impact that will affect not just the UK but the global markets as a whole. One of the main driving forces behind the financial market’s immediate reaction has been the growing uncertainty about the UK’s future economic growth, and Brexit is sure to increase the amount of friction experienced between the United Kingdom and its trading partners overseas. Some of the biggest companies, unsure whether they will be able to access the common market in future in order to trade services and goods, are likely to postpone or freeze major investments within the country and this raises the prospect of an imminent slowdown in the world economy due to the interconnected nature of global business.

Brexit’s Effect on the UK Markets

As economic activity slowed down unexpectedly, the British currency was the first clear casualty of Brexit, as the pound depreciated significantly against the other primary world currencies. Just two days after the leave vote, we saw the pound drop to its lowest rate in over 30 years, and the reduced value of the Pound Sterling has impacted upon the value of UK-based businesses. While some large British exporters like BAT, Rio Tinto and BP are likely to welcome the declining value of the pound due to the reduction in their domestic costs and the proportional increase in their export value, other domestic producers who require imported components will experienced vastly reduced profits together with an increase in their costs. It is this mix of scenarios that can be attributed to the UK stocks and shares market’s mixed reaction. Not only has the Pound dropped sharply in value, but the exchange rate between other major currencies and Sterling has become unprecedentedly volatile and this makes it much more difficult for investors to make an accurate prediction about companies’ projected earnings and this too can lead in the medium and long term to further selloffs.

Brexit and Other World Markets

While it is very easy to think of Brexit solely in terms of the UK economy, its effect is not only limited to Britain. The UK has one of the biggest world economies, with billions of pounds of services and goods being imported every year from all over the world. Should British businesses and consumers reduce the amount of goods they import from overseas because of a decline in their purchasing power, other world economies must necessarily slow down in response. It is estimated by the Economist Group that for each point that the UK’s economy declines in growth, other EU countries will also experience a decline of a half to a third of a point, and this will result in these countries too experiencing lower profits. It is for this reason that all of the European markets saw a decline following the Brexit vote, and as the UK represents one of Asia’s largest importers, the result of the vote also caused a significant negative reaction from the stock markets in Asia.

Brexit and Safe Haven Assets

Brexit is an unprecedented event, and therefore the way that economic events are going to unfold over the months to come is impossible to predict. For this reason, investors began to think about protecting their assets from the worst possible outcome, and started to move capital into “safe haven” assets like US Treasury Bonds, gold and Japanese Yen. This caused a sharp increase in the value of these assets, with the demand going so high for US Treasury Bonds that their price rose to an all-time high within just a couple of days of the Leave vote.

The US Stock Market and Brexit

Brexit has had a complex impact upon the stock market in the United States. Immediately following the vote, the primary US indices showed a decline of around 5% with a significant number of American investors switching their equity holdings for safer Treasuries. However, within just one week, there had been a complete reversal in the fall in equities and within a fortnight, the S&P 500 Index had reached its all-time high. A survey carried about by the Wall Street Journal among leading economists discovered that forecasters were not going to make any major change to their projections regarding the economic growth for the coming year and the year after, and were making no changes to their outlook regarding the rate of US unemployment. There may be two different reasons why Brexit has had a lower impact on the market in the US. Firstly, the American economy is relatively isolated, with only around 15% of the its GDP being related to international trading. Secondly, over the previous 18 months, investors in the United States had anticipated a potential increase in the interest rates together with a possible negative impact upon the profits of companies. After Brexit, and all of the uncertainly in the global economy that has accompanied it, this increase was put on hold by the Fed and this has allowed the US market to retain enough liquidity to go higher.