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The UK files for divorce: what next?

by
01 August 2016, at 1:00am

Adam Bernstein examines the immediate effects of the vote to leave the EU and considers some of the potential issues that may arise, such as oil prices.

THE ELECTORATE HAS SPOKEN and in a stunning victory for the Brexit campaign, the UK is to leave the European Union. But what does the vote really mean – how will our economy and businesses be affected?

The first point to note is that article 50 of the Lisbon Treaty, the clause that determines how a member state leaves the EU, is not, despite the former Prime Minister David Cameron’s original promise, going to be triggered immediately.

Not unsurprisingly, Mr Cameron resigned saying that it will be the job of a new party leader and Prime Minister to start the exit process. That person is now Theresa May. But if law rm Mishcon de Reya wins its argument, article 50 cannot be triggered until Parliament repeals the 1972 European Communities Act – the legislation which enshrines the UK’s membership of the EU – irrespective of what politicians declare.

Immediately after the vote was announced, Mr Cameron tried to steady the ship – something that Mark Carney, the Governor of the Bank of England and George Osborne, the Chancellor of the Exchequer at the time also wanted to do. However, the markets were clearly in a panic.

Consider that in the summer of 2015 the pound against the euro had risen to €1.42, but by the start of the week of the vote it was down to €1.24. As the polls closed it had risen to €1.31, but once the vote result was made public it dropped through the floor to €1.22.

However, now that we have a new government and some form of stability it has recovered to (at the time of writing – 15th July) €1.20. The dollar did something similar and fell to €1.32 – a 10% fall to a rate not seen since 1985 – but is back up to almost $1.34. Not good but it could be worse.

The London stock market saw just as much turmoil and had fallen more than 8% over the morning after the vote before recovering to only being 4% down – again, something not seen since the collapse of Lehman Brothers in 2008, the precursor to the last recession.

Other global markets followed suit – Italy was down 11%, Germany fell 7.5%, and France had lost 9%. By 15th July, London was 5% up on the pre-vote close while other markets recovered too but were still underwater – Italy was 7% down, Germany 2% down, and France 3.5% down. The only saving grace is, as Mr Carney put it, that the banks have more cash in reserve and have been stress-tested so that bank failure is very unlikely.

So what now?

UK law, at least that based on EU legislation, isn’t going to change overnight and in many cases will mirror whatever Brussels passes. Why? Because if the UK is to trade with Europe we’ll have to comply with their rules.

In other domestic matters, such as health and safety and employment law, the former follows much which is common-sense and with regard to the latter, it would take a very brave government to repeal legislation that gives, for example, workers holiday entitlements and rest breaks while offering protection from discrimination.

What will be interesting to see is how, post-exit, UK firms do in recruiting staff as it’s entirely possible that the automatic right of EU nationals to live and work in the UK could be curtailed (and vice-versa).

But there are other areas for concern. Will the UK stay part of the Single Euro Payments Area, the system for simplifying cross-border euro bank transfers? While the UK is not part of the eurozone, many firms will have euro accounts.

There will also be issues with the free movement of goods, capital and people. Border controls will change and firms buying or selling in Europe may well find that tariffs and controls are imposed, adding increased cost and time when moving goods.

The flipside is that the UK will be free to negotiate its own trade deals with non-EU countries and it’s arguable that importers could see some duties on goods fall – with much manufacturing done in the Far East that could be something positive.

Further, in the short term, and until the pound recovers fully, the cost of imports will rise while exporters should be able to capitalise on their position of being more competitive.

Many commentators believe the end result of a weak pound, however, is going to be rising in ation which in turn will place extra pressures – including that on demands for rising pay – on businesses already struggling to cope with rising competition.

A serious element to consider is the cost of oil – priced in dollars – and the Petrol Retailers Association predicted the 3p per litre plus rise in fuel despite a fall in the price of oil. This will price itself into both oil-based products and the cost of deliveries.

While the Bank of England is not going to make any knee- jerk reaction changes, and Mr Carney was very calm when he addressed the cameras, the reality is that he said the bank would take “all necessary steps” to support the financial system.

Clearly the bank had already drawn up contingency plans which included deploying up to £250 billion to support the pound and quite possibly altering interest rates – some suggested that rates could rise to make the pound more investable while others were advocating that rates could fall to zero (from 0.5%) to shore up the UK economy.

Interestingly, the markets didn’t react much when interest rates weren’t changed when the Bank board met in July despite widespread anticipation of a rise.

Misery for some

Leaving the EU – and the run-up to the event – could bring misery for some. As noted, the stock markets have fallen and the banks and the housebuilders in particular have seen their shares hit badly – at the time of writing Bovis Homes shares were down 25%, as were Taylor Wimpey and Persimmon.

Looking at home and electricals retailers, Dixons Carphone was down 22% and AO had lost 13%. Could this be a forecast of the end of the housing boom? Could homeowners and consumers start to feel a chill? How will this slowdown affect consumer spending patterns in other areas?

Share performance depends on profits so those investing in exporters should do well. But by extension, others may, depending on business sector, perform less favourably as the falls in the stock market have proven.

This will undoubtedly affect those with pensions, ISAs and other forms of stock-based investment. And if the Bank of England steps into helping the economy with more quantitative easing (in essence, “printing” electronic money) it’ll adversely affect bond rates which, among other things, will lower annuity rates for pensioners.

It’s badly timed, but the government announced at the end of June that household incomes had risen to an average £473 a week – £800 a year more than in 2013 to 2014. It’ll be interesting to see the gures announced in June 2017.

Taxation

While some suggest that elements of taxation could fall away because of the end of being a net contributor to the EU’s coffers and the removal of the requirement to have a minimum rate of VAT (15% for standard rated items, 5% on domestic fuel), others including the Institute of Fiscal Studies believe the government’s austerity programme could be further extended even though the former Chancellor had planned to end the programme and also lower corporation tax to 15%. The decisions rest with the new Chancellor, Philip Hammond.

Could the vote lead to a further political break-up? Possibly. Politicians in other member states are calling for a vote – Marine Le Pen in France, Mateo Salvini in Italy and Geert Wilders in the Netherlands. And then, of course, Scotland’s First Minister is now angling for another independence vote and there were calls from Sinn Fein for a vote on Northern Ireland’s status.

One thing is certain: we are now slowly walking towards a brave new world.