The EU Referendum
Britain Takes Back Control. Or Does It?
‘I declare that the total votes cast for Remain were 16,141,241. The total votes cast for Leave were 17,410,742.’
‘I will do everything I can as Prime Minister to steady the ship… but I do not think it would be right for me to be the Captain.’
Two announcements, coming little more than an hour apart, which together sent the UK political system and its economy into wholly uncharted waters and sent stock markets and currency markets around the globe into turmoil.
The UK joined the European Union – then popularly known as the Common Market – on January 1st 1973. Ireland and Denmark joined at the same time, taking the original six members up to nine. On June 23rd 2016 the UK voted to leave the EU, now comprising 28 members and with five candidate countries hoping to join. There was a majority of over one million in favour of Leave, and – despite a petition calling for a second referendum passing the two million mark – that appears to be that. And, as several European leaders have said, ‘out is out.’ The ‘most complicated divorce in history’ is about to start.
The Instant Reaction
Both the FTSE 100 index of leading shares and the pound rose steadily throughout Thursday 23rd June, as the markets anticipated a win for Remain. The bookmakers reported several six-figure bets on the status quo. However, as the early results came in and it became apparent that Leave had done far better than expected, both the pound and FTSE Futures (trading in the Far East) went sharply in the other direction.
The FTSE fell by 8% after opening in London, with shares in banks and housebuilders being especially badly hit: at one point shares in Barclays and RBS were down by more than 30%. By the end of trading on Friday 24th June, the FTSE had bounced back and it closed 2.8% down on the day at 6,139. To give that some context, the FTSE ended 2015 at 6,242 and finished both January and February below that level. Supporters of the ‘business as usual’ school of thought would also point out that the FTSE finished Friday 17th June at 6,021 – up 70 points on the day. If you follow that line of thought then the prospect of Brexit was worse for the stock market than the reality.
The pound was also hit sharply. Having been as high as $1.50 on the Thursday, it touched levels on the Friday that hadn’t been seen since 1985, at one point falling by 10% to $1.33. It finally closed the day down 9% at $1.36. In early trading in the Far East, on Monday 27th the pound was continuing to fall against the dollar.
In truth, there was always going to be a sharp reaction, whichever side won. But with Leave having triumphed, the next few months will be especially critical. Bank of England Governor Mark Carney will undoubtedly be a key figure. He says the bank is ‘well prepared’ and he stands ready with £250bn to pump into the banking system: whether that would be enough to stand up to market sentiment and determined selling of sterling by the hedge funds remains to be seen.
Another key figure, George Osborne, is now already out of the cabinet picture. Having made a statement early on Monday 27th June, seeking to provide reassurance about the UK’s economic and financial stability, it is somebody else – in this case, Philip Hammond – who will take on the responsibility of being Britain’s post-Brexit Chancellor of the Exchequer.
The reaction around Europe
There was a pre-Referendum boost for the Leave camp when Markus Kerber, the head of Germany’s equivalent of the CBI, said that post-Brexit trade barriers would be ‘very, very foolish.’ The UK is a highly significant market for many German and continental firms, and when the decision was announced there was plenty of conciliatory language. German Chancellor Angela Merkel was quoted as saying ‘there is no need to be nasty to Britain’ over the ‘divorce’ terms.
However, pressure developed over the weekend following the vote for the UK to speed up those ‘divorce’ talks. EU President Jean-Claude Juncker said it ‘was not an amicable divorce’ – but then again, he claimed, it had never been ‘a deep love affair.’
Several right wing groups across Europe saw Brexit as legitimising their own calls for referenda on continuing membership. But pro-Europe groups were also opening the champagne, claiming that the UK had always been a brake on further European integration and cooperation.
The UK’s credit rating
One of the first casualties of the Brexit vote was the UK’s credit rating. Credit ratings agency Moody’s cut the outlook for the UK’s credit rating to negative, saying that the result would herald ‘a prolonged period of uncertainty.’ Standard & Poor’s quickly followed suit, downgrading the UK from AAA to AA and predicting a ‘a deterioration of the UK’s economic performance, including its large financial services sector’. Fitch also downgraded from AA+ to AA, warning of an ‘abrupt slowdown’.
So what happens now?
As of late on July 13th, the UK has a new Prime Minister. After Boris Johnson, the early frontrunner, was apparently usurped by his ‘dream team’ compatriot Michael Gove, and Andrea Leadsom pulled out, Theresa May was left as the last woman standing. David Cameron left 10 Downing Street accompanied by his family and the most significant piece of the post-Brexit reshuffle was complete: Theresa May is our Prime Minister for the foreseeable future. May supported Remain, but did so very, very quietly and, as it stands, she appears to have the backing of large swathes of Conservative MPs to unite the party and take Brexit forward.
In the run-up to Mrs May’s appointment, several European leaders have called for a ‘quickie’ divorce and the world’s financial markets were always unlikely to grant the UK three months of a Conservative leadership battle to find a new leader. The Prime Minister has now assembled a team – including Mr Hammond, Mr Johnson and David Davis, in the newly created role of Secretary of State for Exiting the European Union – and the work of negotiating our exit can begin.
Cameron always wanted the next PM to invoke Article 50 – the formal process giving two years’ notice of our intention to quit the EU – and he will now certainly get his wish. Should the process not be completed within two years, then it can only be extended with the consent of all the other EU members.
The new Prime Minister may argue however, that Article 50 works against the interests of the country leaving the EU: Mrs May may seek a period of informal negotiation first.
As mentioned above, however, if there was one clear trend that emerged over the weekend of the vote, it was the desire of many European leaders to see Brexit happen quickly. They fear that an amicable, drawn-out settlement would simply encourage other countries to seek their own version of Brexit. Theresa May can expect to hear ‘get on with it’ in several different languages.
How will Brexit affect your finances?
At this very early stage, the full impact of Brexit on our personal finances remains unclear, but we can already observe the following points.
The Pound and Prices
If the pound continues to fall then importing goods from other countries will be more expensive. This will push prices up and lead to a rise in inflation: but it’s good news for exporters as their goods become cheaper to buy.
An early example of prices going up will be seen on the petrol forecourts. Wholesale petrol prices are quoted in dollars, so as the pound falls against the dollar, petrol prices will rise. The Petrol Retailers Association are already talking of a rise of 2-3p per litre.
Savings and Investments
Without question, the biggest threat to the stock market and your savings and investments is a prolonged period of uncertainty – the one thing markets hate above everything else. Assuming everything is worked out relatively quickly then the stock market should return to a normal pattern of trading – and as George Osborne said at several points before departing his governmental post, the fundamentals of the UK economy are relatively strong. We certainly cannot assume that Brexit would be bad for shares: in the long run the stock market will be affected by events around the world – China’s economy, growth in the Eurozone, the outlook for the US – as much as it will be affected by Brexit.
Clearly any rise in interest rates (see below) would be good news for savers.
Interest rates and Mortgages
Before the Referendum vote, Remain were saying that a vote to Leave would push up borrowing costs, leading to higher mortgage payments and increasing renting costs. But if Brexit were to lead to a period of low growth then interest rates could be cut in a bid to stimulate the economy. David Tinsley, UK economist at UBS, has said that he expects two interest rate cuts from the Bank of England over the next six months, taking rates from the current 0.5% to zero.
There appears to be some consensus that Brexit could lead to a fall in house prices, especially in London and the South East. The Treasury has spoken of a fall of 10-18% over the next two years. Clearly not good news for existing homeowners, but anyone with children struggling to get a foot on the housing ladder may take a different view.
During the campaign, George Osborne gave dire warnings of tax rises in the event of a victory for Leave. This would be directly contrary to the Conservative’s election pledge and would be difficult to implement. On the face of it, you could have said that an extension of ‘austerity’ for a further two years beyond 2020 was much more likely, but the former Chancellor and Theresa May, before she was appointed Prime Minister, appeared to be uniting behind an approach which abandons the fiscal charter and effectively loosens austerity. A further cut in corporation tax, to encourage businesses to remain in the City, had already been announced by Mr Osborne.
The Leave campaign did give a pledge to remove the 5% VAT on domestic fuel required by EU law – but there were so many pledges flying about that it is perhaps best to not build this into your household budget just yet.
David Cameron did claim that a vote to Leave would threaten the ‘triple lock’ on pensions, but this presumes a poorer economy and a lower national income. If economic performance did deteriorate after Brexit, then the Bank of England might opt for a return to Quantitative Easing (QE) and/or lower interest rates. More QE would push down bond yields and with them annuity rates – so anyone buying a pension annuity would get less income for their money.
What will the UK’s relationship with Europe be when the dust has settled?
At this stage, it’s almost impossible to say. The Labour party is still in a level of turmoil more with the majority of the Shadow Cabinet having resigned (or having been sacked in the case of Hilary Benn). The papers are reporting that pro-Remain MPs may attempt to block the decision of the Referendum. SNP leader Nicola Sturgeon is also threatening to veto Brexit and is demanding a second Scottish Independence referendum.
But let’s assume that Brexit goes ahead. The more rational Leave campaigners have been at pains to stress the UK’s links with Europe: the more rational European leaders will not risk losing such a big market, especially as Europe moves slowly out of a recession. Perhaps the best guess is that the UK will leave the EU (and quite quickly) but will retain some sort of ‘associate’ status. This would involve the UK making some contribution to the EU budget, accepting some of its trading rules and doing its best to control immigration with a points-based system, all things which potential Prime Minister-in-waiting, Boris Johnson, had started to discuss publicly… before he was no longer Prime Minister-in-waiting! In the best traditions of politics and darkened rooms, a compromise may eventually be reached between Theresa May and her European counterparts – with both sides spinning it as a win. Will it work? No one knows; but when the dust finally settles, we may find that ‘out’ was not quite ‘out’ after all.
The next few months will be interesting, to put it mildly. We appreciate that our clients may have concerns and questions, so please do not hesitate to get in touch with us at any time.