BREXIT: KEEP A COOL HEAD IN VOLATILE MARKETS
30 June 2016, Written by Michael Knox
THE British withdrawal from the European Union will prove to be another crisis of confidence, according to Morgans.
The stockbroker has likened Brexit to numerous Greek sovereign debt crises, which shocked the markets at the time but regained stability as the issues were managed.
Morgans chief economist Michael Knox shares his perspective on Brexit in a bid to separate fact from fiction.
What are markets dealing with regarding Brexit?
Brexit is a political crisis, and clearly it's a short-term market crisis, but it's not necessarily an economic crisis. The medium-term economic impacts of Brexit should not be as bad as markets fear. That said, Brexit is a significant political and constitutional crisis within Europe.
What were the motivations of the Leave movement?
Brexit has been driven by long-term political motives much more than the short-term economic. The 'Leave' argument, championed by Boris Johnson, aims to preserve the UK's economic sovereignty and arguably its democracy as it currently knows it.
The alternative is the UK evolving into a smaller part of a larger European super-state. The UK would then have no more rights and self-determination than an American state has relative to the American Federal Government.
The British vote for Brexit is similar to the vote by the Swiss to remain outside of the EU to preserve their political freedom. Although not formally part of the EU, the Swiss have negotiated treaties which allow them to function almost as if they were part of the EU.
Why push for a Brexit now?
The fear is that as time goes by Britain will lose its rights as an independent state. It is possible to leave now by political means.
In future decades it may find itself in the same position as the state of Virginia in 1861. An attempt to leave might provoke a civil conflagration. In economic terms what the Leave camp want is economically very little different from what they have now.
The issues are political not economic. We think it may actually be relatively easy for a long-term agreement to be found as it was in the case of Switzerland. A renegotiated deal may cost both sides very little, but the process to get there may be bumpy.
What are the potential economic impacts to the UK?
The economic impact is not determined by Brexit itself, but by the kind of deal Britain does with the EU after it leaves.
The damage caused is directly proportional to the success that populists may have in restricting trade and immigration. The more open the trade and immigration regimes after leaving the EU, the less the damage, and vice versa.
If the UK renegotiates a position similar to Switzerland, then it can come up with a solution that is very close to its current position, with an outlook for economic growth that is very similar than should they remain in the EU. That is the most likely outcome in my view.
What gives you comfort that the UK can actually strike this type of deal with the EU?
The UK is an inherently strong economy going through a short-term political crisis. It is the fastest growing major economy in the EU.
It's growing 1 per cent faster than the German economy. At this rate, in 15 years it will be the largest economy in Europe. The UK is strong enough to get almost any kind of deal that it wants.
What is the risk the EU drives a hard bargain in order to deter other EU members from leaving?
Britain is the second largest economy in Europe and its major financial capital. You have to treat a country like that with respect.
Paul Ryan, speaker of the US House of Representatives and arguably the second most powerful leader in the US, said over the weekend that Britain is the one indispensable ally of the US.
We have no doubt that the US would support a free trade bill with the UK. So the UK has strong allies should the EU choose to beat up on it.
Ultimately, we think that would be more damaging for Europe than it would be for the UK.
When is a new deal with the EU likely to occur?
Unfortunately, negotiations cannot commence until the Brexit plebiscite is enacted into law by way of vote in the House of Commons.
With the resignation of David Cameron, the mechanics for this don't look like being in place until October. The UK then starts a two-year process of renegotiation with the EU before any new agreements are even enacted.
How are markets likely to cope with this?
The three most important central bankers surrounding this, including Bank of England Governor Mark Carney, European Central Bank President Mario Draghi and Chair of the Federal Reserve Janet Yellen, have all said they have plans in place should Brexit occur.
Each of these central banks is poised to add enormous amounts of liquidity to the market which will absorb market volatility.
The definitive action is likely to be a meeting of the Monetary Policy Committee of the Bank of England in mid-July, where we can expect the announcement of a period of Quantitative Easing. We think this will lift confidence in the financial system and bring market volatility to an end.
Is there a risk that anti-EU rhetoric intensifies in Europe?
Brexit has provoked fear among other EU members. We have already seen the Leave camp make various conciliatory statements to defuse the situation.
We think the new UK leadership will act to reassure other EU members as the process unfolds. Given that Brexit's motivations were political rather than economic, we would also question whether other major EU economies like France and Italy are really willing to make this an economic fight?
What is the risk of a contagion effect and a potential break-up of the EU?
We think the probability of others leaving the EU is low.
For example, 72 per cent of the Greek population wants to leave the EU but 62 per cent wants to keep the benefits of the Euro. The result is that they will stay.
Could this crystallise new votes of independence from Scotland and Northern Ireland?
This is possible but we think unlikely at this stage. Boris Johnson has been reassuring the country about the unity of the country, at the same time as reassuring the country about its closeness to Europe.
What he ultimately wants to achieve is minimalist in an economic sense, which we think will become clearer as more detail becomes known.
What is the outlook for Sterling?
QE would clearly put more pressure on the pound in the short to medium term. However, once the Bank of England acts, and markets regain their confidence in the robust outlook for the UK economy, then we think the pound can then begin to recover from what we think will prove to be a generational low.
Can the prospect of lower immigration harm the UK economy?
Again these details are to be renegotiated but we do know that Boris Johnson wants an immigration system similar to Australia, based around highly skilled migrants and family reunion.
We think the UK will still have access to enough qualified labour to keep down wages pressure and sustain the growth rate. Again this is similar to Switzerland, which achieves a long-term growth rate that is only slightly lower than it would achieve if it were a full member of the EU.
We don't think this will make a material economic impact.
Author: Michael Knox
About: Michael Knox is chief economist and director of strategy at Morgans. He joined the stockbroking and wealth management firm in 1988, and has served on many Queensland Government committees.