After a night of high drama, the British public voted to end their 40-plus-year relationship with the European Union (EU) by a margin of 52% to 48%. With turnout high at 72%, the people certainly seem to have spoken.
Early indications on the night of the vote suggested that the “Remain” camp would prevail, with the sterling-dollar exchange rate ‒ the bellwether for Brexit risk ‒ touching a high for the year of $1.50 per pound. However, as the night progressed and swathes of England and Wales voted to leave, expectations turned sharply, and with them, the fortunes of the pound. In turn, global equity markets saw similar levels of volatility whilst gilt and bund yields hit new lows.
The shock of the vote will dominate initial market moves, and will clearly provide risks for the medium term.
Near term, the UK economy will be pulled lower by the uncertainty created by the referendum vote. As a result, we expect the Bank of England to cut the official interest rate to zero from 0.5%. If it feels the need to do more, we expect a reintroduction of quantitative easing rather than a move to lower the official rate into negative territory.
For the medium term, we expect a period of greater relative calm, not least because the transition to life outside the EU will take time to negotiate. Furthermore, the leadership of that negotiation needs to be resolved. David Cameron has announced he will step down as prime minister by October, meaning that a leadership contest within the Conservative Party will take place over the summer. Only after this is settled – and the UK has a new prime minister – will negotiations around the EU separation begin. The time for these negotiations would likely be up to two years under Article 50 of the Lisbon Treaty. However, we would expect informal negotiations to start before the UK government formally initiates the exit process.
These things take time, and time can heal what at this moment may seem like a raw wound. However, coming at a time when the global economy is vulnerable to unexpected shocks, periods of political instability create significant risks. Brexit increases uncertainty in the outlook for the UK, underlining our secular themes of rising political risk and insecure stability for the global economy.