By: Russell Swansen, Chief Investment Officer, and Cortney Swensen, CFA, Senior Research Analyst Fixed Income Investments, Thrivent Asset Management August 01, 2016
When the United Kingdom (UK) voted to leave the European Union (EU) June 23, the decision sent the world’s markets briefly into turmoil. Although order has since been restored in the global markets – with most rebounding strongly from the sudden sell-off – the UK still faces many obstacles to maintaining its economic strength and global trading status.
Britain has already sworn in a new prime minister following the resignation of David Cameron. The new prime minister, Theresa May, was not a proponent of Brexit – and had hoped to remain in the EU – but she has vowed to see the process through and oversee a series of new trading pacts designed to maintain the UK’s ability to trade freely within the EU.
That process is unlikely to be a smooth one. France and other EU members have signaled an intention to make UK’s exit as painful as possible to set an example for other EU members who may be tempted to leave the EU.
However, other potential trade partners from outside the EU have come forward in hopes of expanding their trade agreements with the UK. Unencumbered by the strict regulations of the EU, partners outside the EU, such as India and China, may find it easier to negotiate more beneficial free trade agreements with the UK.
UK Chancellor Philip Hammond has already opened trade discussions with the Chinese Ministry of Commerce,1 while UK Business Secretary Sajid Javid visited Delhi in July to broach trade talks with India, and announced plans to visit the U.S., China, Japan, and South Korea in the months ahead.2
But the greatest challenge for the UK may be devoting the time and resources to negotiating new trade agreements with the other 52 member nations of the EU.
Brexit advocates had pushed their proposal by railing against the UK’s ongoing contribution to the EU’s budget and the free movement of people across its borders. Ironically, in order to preserve a trade relationship with the members of the EU, Britain may still be required to contribute to the EU’s budget and may still be compelled to keep its borders open. Yet, it will lose its EU voting rights and much of its influence over trading policies within the EU.
The UK may also lose a lot more. Airlines, banks and other businesses that benefit from an open market have indicated a possibility of moving out of the UK and over to Europe. France has already begun to throw out the welcome mat, and has been discussing possible tax incentives to entice British banks to make the move across the channel.3
The Brexit fall-out has already caused a dramatic decline in economic activity, according to a leading economic index released July 22. The IHS Markit Flash UK Composite Output Index fell to 47.7, its lowest level since April 2009. A reading below 50 indicates an economic contraction.
Both manufacturing and service sectors experienced a steep decline in orders and output, according to survey data collected for the Markit indexes. Output dropped 4.7 points for the month while new orders were down 6.8 points – each of which represented the largest single month decline on record.
Expectations also took a hit, as the Markit Services Business Expectations Index plunged 10.4 points, which was also the largest drop on record.
According to Chris Williamson, the chief economist for Markit, “the survey is signaling a 0.4% contraction of the economy in the third quarter, though much, of course, depends on whether we see a further deterioration in August or if July represents a shock-induced nadir. Given the record slump in service sector business expectations, the suggestion is that there is further pain to come in the short-term at least.”
The one silver lining was that the weaker pound helped increase the level of exports, although, as Williamson put it, “producers also suffered the flip-side of a weak currency as import prices spiked higher.”
The UK still faces a mountain of work to adapt to life after Brexit, including the tedious task of drafting a raft of new trade laws and regulations to replace the covenants of the EU pact.
One lesson the UK may already be learning from Brexit is that the siren call of isolationism may sound enticing in a stump speech, but the reality may be a far different story.
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