What does Brexit mean for London, the UK and Europe?
The UK’s vote to leave the EU shocked currency and stock markets, and has led to an environment of economic and political uncertainty. Against this backdrop, we have revised our main scenario projections for UK real GDP growth to 1.6% and 0.6% in 2016 and 2017 respectively, down from 1.9% and 2.3%. This revised estimate assumes that the Bank of England embark on some monetary loosening due to the expected reduction in aggregate demand, and in an attempt to stabilise financial markets. We’re also assuming that fiscal policy is supportive of growth.
But Brexit will be on the minds of policymakers outside the UK, and indeed the EU, as well. The Swiss central bank has already intervened in the foreign exchange markets and the US dollar appreciated slightly following the referendum - though it hasn't reached the levels it was at earlier this year. Therefore, we are still expecting the Fed to raise interest rates, although probably not until December or later.
For now, the question on many people’s lips is what will the UK’s future relationship with Europe look like. The main exit options discussed are membership of the European Economic Area (EEA); some form of bilateral free trade agreement with the EU; or trading under World Trade Organization (WTO) terms. The implications for the UK and EU economies will largely depend on which, if indeed any, of these scenarios comes to fruition.
From a trade perspective, EEA membership would see the UK retain full access to the Single Market. A free trade agreement could involve more limited access to the Single Market, but would at least reduce many trading barriers such as tariffs on goods. A WTO-type scenario would see trade barriers imposed, which would impact the UK and, in particular, economies that do a lot of trade with the UK such as Ireland.
Does the leave vote mean London’s position as a leading international financial centre will weaken? If the UK loses Single Market access, UK firms and EU firms won’t be able to passport financial services businesses, products and services in and out of London, which is likely to have a significant impact. Based on current expectations, only EEA membership would see this access maintained. Our financial services attractiveness indicator shows that London is currently Europe’s leading financial centre, but the loss of passporting could call this into question over the longer-term.
The next edition of Global Economy Watch will be published in early September.