A look at the potential impacts of the Brexit decision

Peter Westaway, Vanguard’s Chief Economist for Europe, examines potential impacts of the Brexit decision on the United Kingdom, European Union, and investors.


Global macro matters

Lara DeLaIglesia

Lara de la Iglesia: So, I have to ask, what might be the expected impacts to the U.K. economy for the more probable Brexit scenarios?

Peter Westaway: So, there’s a lot of debate about that. I mean the simple answer is we don’t know for sure. Immediately after the vote, many commentators, ourselves included, to be honest, thought that there would be a much sharper downturn in activity than there actually ended up being. The impact of uncertainty because people suddenly didn’t know what was going to happen in terms of trading arrangements might have caused a big fall-off in investment; people stopped spending money.

In the end, those things didn’t happen suddenly, and because the Bank of England, because the government loosened policy, all of that meant that the immediate impact was quite muted.

Actually, two years on, most commentators, ourselves included, think that probably the U.K. is about 1% worse off because of the Brexit vote compared to the situation if they hadn’t made that decision.

Peter Westaway
Peter Westaway

And the simple way of looking at that is to see that, while the rest of Europe and the U.S. is now growing moderately strongly, the U.K. is still stumbling along at around 1%, 1.5% growth. And we think, normally, we would have expected a bigger upturn in growth.

So, for now, those impacts in the short run are there but they’re not huge.

Looking further forward, the long-run impact of the U.K. weakening their ties with their largest trading partner is likely to be that trade will be lower. That means GDP will be lower for a while, and the knock-on consequences that might have for productivity growth, and more generally the ability of the U.K. to innovate and to find new opportunities, is perhaps hindered.

So that’s why we think, in the long run—and many commentators have done these calculations—the consensus is the level of GDP could be 5%–6% lower. Could be even more than that.

Lara de la Iglesia: So, given the uncertainty around the possible Brexit scenarios, how has the rest of the European Union reacted, and what impacts might we expect there?

Peter Westaway: Yes, that’s an interesting question because before the Brexit vote, and immediately afterwards, there were many people who feared that the Brexit vote may set in motion a domino effect, where other countries looked at what was going on in the U.K., and thought, “Well, maybe we should leave the EU as well.”

In the event, that hasn’t happened, and if anything, the countries of Europe have been brought more closely together. I mean, that’s been helped by the election of the Macron government in France, which has a very pro-EU tendency as well.

So, overall, I think the EU has been, probably, brought more closely together because of this rather than thrown apart.

That’s not to say that there aren’t still populist, anti-euro, anti-EU tendencies in the euro area and in Europe. But, perhaps, they’re just not quite as strong as they were a few years ago. I mean, the obvious danger point would be in Italy, where, at the moment, a populist government led by the Five Star movement and the Northern League are now in a coalition where there’re some question marks about whether they really are committed to the EU or to the euro. And, if they were to start making big changes in policy, that would definitely undermine the integrity of the whole European structure.

But, for now, we don’t think that’s going to happen and so the Brexit situation is an irritant for the EU. It’ll certainly have a negative impact on activity in Europe, certainly for those countries that are closely integrated, like Ireland, the Netherlands, France, and so on. But I think the show will stay on the road in a way that, maybe, some people were fearing it wouldn’t when this thing first started.

Lara de la Iglesia: Okay, thank you. So, until we know what decisions will be made around Brexit and how things are going to play out, what guidance would you give to global investors?

Peter Westaway: Yes, that’s a difficult one. I mean, in the run-up to Brexit, many people were saying, “Should we avoid sterling, should we avoid going anywhere near it?” And I think, in retrospect, markets didn’t react very negatively in the way people feared.

And so, again, looking forward, because there are many different options on the table, if there was a very bad Brexit, I think sterling would fall, sterling assets would fare badly. But if we end up having a much softer version of Brexit, or even no Brexit at all, then I think sterling and sterling assets could do well.

So, unless you have a big conviction on which way it’s going to go, I think just keeping U.K. assets as part of your globally diversified portfolio is still a sensible way to go. It’s very difficult, at the moment, to predict exactly how this is going to play out.

And, you know, the political experiences that we’ve had over the last couple of years around the election of Donald Trump, Brexit, events in Europe—it’s very hard to predict in advance what’s going to happen. And it’s also very hard to predict, even if you did know what was going to happen, how markets will respond. And so, in that environment, keep it simple.

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