The knowns and unknowns of BREXIT
Donald Rumsfeld may have been lampooned at the time, but the advice that the then US Secretary of State gave in 2002 seems perfect for the position in which the UK finds itself following the country’s Brexit vote. Rumsfeld said: “There are known knowns. There are things we know we know. There are known unknowns. That is to say, there are things we now know we don’t know. But there are also unknown unknowns. There are things we do not know we don’t know.”
As the UK ponders the likely future shape of political and economic landscape in the wake of our vote to leave the European Union, Rumsfeld’s tortuous construction provides a helpful framework for looking ahead (not least, precisely because it is so tortuous).
In the known knowns category, we know that the UK has opted to quit the EU and that the mechanism for doing so is spelledout in Article 50 of the Lisbon Treaty; this specifies that member countries wishing to leave the EU must give formal notice of their intention to do so and then have two years to negotiate the terms of their withdrawal, including their subsequent relationship with the countries left behind. We also now know that Teresa May will be the Prime Minister charged with managing this process.
The list of known unknowns is longer. We know that we don’t know when the Government will trigger Article 50. We know that we don’t know what the Government will eventually push for when negotiations begin, or how the EU might respond. We even know that we don’t know when this process will end and the UK will formally exit.
As for the final category, unknown unknowns remain, by definition, out of sight. But on the evidence so far, it would be wise to expect plenty more shocks along the way. The resurgence of the Labour Party under a new leader, perhaps? A move in Parliament to defy the referendum result? A last-minute offer of a better deal from the European Union? A new Governor of the Bank of England if pro-Brexit campaigners force Mark Carney out?
Against this backdrop, making sensible predictions about the economy or politics is pretty challenging. Moreover, there are now two distinct time periods to consider. The short term, up until an exit deal is agreed with the EU, will be characterised by uncertainty, since no-one can be confident about what lies ahead. Thereafter, we’ll at least have a clear picture of the future, for better or for worse.
Starting with the first period, it’s very difficult to find an economist who doesn’t expect the uncertainty to damage the UK economy, with businesses (including foreign businesses investing in the UK) unwilling to make any significant decisions until the outlook becomes clearer. Economists at IHS Global Insight have already slashed their growth forecasts – to 1.5 per cent from 2 per cent for 2016 and, much worse, to 0.2 per cent from 2.4 per cent for 2017.
The Bank of England has signalled it is likely, in time, to have to respond to the slowdown with looser monetary policy. The base rate, currently at an historic low of 0.5 per cent, will almost certainly have to come down even further – even to zero. The Monetary Policy Committee may also consider a fresh round of quantitative easing, with the bank buying up gilts and bonds to get money into the economy.
At the same time, however, inflation is likely to rise, with the Bank powerless to take action because its monetary policy efforts will be geared towards supporting growth. As a rough rule of thumb, inflation tends to rise by one percentage point for every 4 per cent that the value of the pound falls, because imports automatically become more expensive. In the week following the referendum, sterling fell by a little over 10 per cent against the dollar, but some economists expect a significant further deterioration – Saxo Bank, for example, has predicted a decline of almost 20 per cent by the end of 2016.
This upheaval is certain to have a significant effect on the property market, but here there are potentially countervailing forces. Certainly, agents have already begun to report buyers putting decisions on hold because they are so uncertain about the future – and not just buyers from overseas, though a slowdown here is already hitting the top end of the London market. On the other hand, with bond markets pricing in lower interest rates, and the swaps market – on which fixed rate deals are priced – already falling, affordability should improve, particularly if lenders are keen to stimulate demand.
The ratings agency Fitch has predicted that house prices could fall back by 25 per cent on the Brexit vote, but plenty of other analysts are far less gloomy – KPMG’s prediction, for example, is a 5 per cent fall outside of London and only slightly more in the capital. What about the longer term outlook for the economy? Well, that will largely depend on the final deal that the UK
reaches with the EU on trade and access to the single market – as well as the extent to which it is able to do new deals with other countries around the world. But there are some effects of Brexit that will persist for the long term whatever happens.
First, the UK’s public finances are likely to be hit by the referendum result – George Osborne announced within days that he was abandoning his target of bringing the UK into surplus by 2019. As a result, the UK is going to have to borrow more and prioritise austerity for an even longer period than previously imagined.
Much will depend on the politics. The new Prime Minister, who campaigned against Brexit, could be more inclined to make compromises in a European Union deal, in which case the impact, at least in the short term, of the UK’s exit is likely to be less dramatic. If Labour is able to put its house in order – and play a part in a cross-party Parliamentary alliance of MPs with less hostile feelings towards the EU – that could be a mitigating factor.