BREXIT: Impact on the financial markets

Many expected economic activity in the United Kingdom (UK) to collapse in the wake of the 23 June 2016 referendum. These expectations were founded on the view that business confidence would fall, in turn leading to a sharp slowdown in investment. Also, consumption was expected to weaken as a r esult of stronger inflation ( brought about by sterling’s depreciation ) and of a decline in consumer confidence. Economic activity has indeed slowed, but it has not collapsed. Turning to the financial markets, the most remarkable developments have been the sharp decline in sterling’s effective exchange rate (EER) and the strong increase in prices for Gilts, notably index-linked Gilts (real yields remaining deep in negative territory). In theory, the EU27 and UK need to reach an agreement on a Withdrawal Bill by this October. Although the deadline for the Withdrawal Bill looms on the horizon, the two parties remain miles apart on many key issues, notably over the border between Northern Ireland and the Republic of Ireland. The risk of a no deal Brexit is therefore uncomfortably high , as underlined by several member s of the British government and the Governor of the Bank of England. Guidelines concerning future relations between the EU27 and U K will have to be sketched out at the same time the two parties reach an agreement over the Withdrawal Bill, but there is no guarantee a trade agreement can be wrapped up rapidly even if there is a meeting of minds over the Withdrawal Bill. Many institutions have attempted to estimate the economic impact of the different Brexit scenarios. Very few conclude that Brexit could have a positive impact on the British economy. It is important to bear in mind that, as recalled recently by the IMF, Brexit is not good news either for EU economies. Obviously, the task of the Bank of England (BoE) has been complicated to no small extent by all the uncertainties: for two years, the central bank’s monetary policy has been largely Brexit-dependent. The central bank has sought to devise solutions to attenuate Brexit’s impact on the City, notably by drawing up a new financial model. Finally, the impact on the financial markets will depend on Brexit’s exact nature. The worst -case scenario would be a failure to reach an agreement over the Withdrawal Bill, implying there would be no transition period, no trade agreement, along with increased political tensions between the EU27 and UK, as the latter would refuse to pay the Brexit bill, as suggested recently by Dominic Raab .