Brexit: Beginning of the end, or end of the beginning?
14 February 2017 | Markets and Economy
The United Kingdom is preparing to negotiate its exit from the European Union. What are the economic implications of Brexit on both sides of the Channel?
Gemma Wright-Casparius (senior portfolio manager, Vanguard Fixed Income Group): Peter, the United Kingdom is expected to begin negotiating with the European Union over its exit shortly. What's occurred thus far, and what would we expect in the near future?
Peter Westaway, PhD (Vanguard chief economist, Europe): It's interesting because it's over six months since the referendum happened, but the government are expected to trigger so-called Article 50 [of the European Union charter] in March of this year. That starts the formal process of the UK leaving the EU. The actual leaving of the EU may then not take place for another two years after that, so it's quite a long, drawn-out process.
And as far as its impact on the economy is concerned, most people think that over the long term, this is probably going to be quite damaging for the UK economy, that it'll probably require our GDP to be lower. Just how much lower is going to very much depend on whether or not the UK has what's called a hard Brexit or a soft Brexit.
It's now looking more likely to be a hard Brexit. And what that means is that because the UK wants to restrict immigration, it probably means we won't have such good access to trading relationships with the EU. So that's probably why we think activity will be lower.
So far though, since the referendum, a lot of people, myself included, thought the activity was going to be hit really bad, a bad hit to confidence, companies would stop hiring people, stop investing. In fact, the UK economy seems to be sailing through it all very nicely. But I think it's maybe too soon to say everything's fine. I think we will expect to see slightly lower growth next year going forward as the real impact of Brexit starts to set in.
Gemma Wright-Casparius: Did we anticipate any type of policy reaction in response to the Brexit and to potential slowdown in growth?
Peter Westaway: Well, we've already had the Bank of England cut interest rates pretty soon after the Brexit vote, and I think that helped to shore up confidence. Ironically, it also helped to weaken the exchange rate, which is also propping up the economy. I think fiscal policy is a lot looser than it otherwise would have been, so all of those things may be helping to explain why growth hasn't fallen away as sharply as people were expecting.
Gemma Wright-Casparius: There's a growing anti-EU sentiment on the heels of the UK Brexit vote and the US [presidential] election. What are the implications for the European economy and our economic outlook in 2017?
Peter Westaway: Yeah, but I think the big worry is because the UK is now thinking about leaving the EU, it might embolden other countries to do the same thing. And so there are a series of political events coming up over the next year, most important, the French election for the new president, the German election. And any one of those could allow this anti-EU sentiment to express itself. And in extreme, that could actually cause a government to fall or even a country leaving the EU or the euro.
I don't think we're going to see that, but all of this uncertainty just undermines the growth picture and it just weighs down on growth in the euro area to an extent.
Gemma Wright-Casparius: So what policies do we expect out of the ECB [European Central Bank], for example, to support growth?
Peter Westaway: Well, we're seeing continuing stimulus being provided by the ECB. They're adding to their process of quantitative easing, which is asset purchases. That's expected for the rest of this year.
And many people are also looking to governments to provide some policy stimulus in the form of fiscal injections. The reality is that with those general elections coming up in Germany and elsewhere, we're probably not going to see that help from government. So it's probably more likely to be the ECB that continues to do the main work in helping the European economy.
Gemma Wright-Casparius: So, do we expect the ECB to be successful in supporting growth in Europe?
Peter Westaway: What we're seeing with quantitative easing, and to an extent with negative interest rates as well, is that policy has been working very slowly, very gradually; and many people think that the more you do QE, the less effective it becomes.
Even so, I think we are gradually getting a return to full capacity in the euro area. But inflation is still well below target, so there's still a lot of work to do. So I'm not an outright pessimist on policy, but it's a long haul. And these headwinds like Brexit, like anti-EU sentiment, the migration crisis in Europe, all of these things are making life more difficult for policymakers.
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