To many people, the plan to have the referendum in the first instance was simply a strategy for the government to give the British people a say in a recurring topic but then put it to bed once the country voted to stay – a foregone conclusion in the eyes of the government, or so they thought. The result of the referendum precipitated an economic shock but there are many more problems to come, and those are the resultant aftershocks from the ‘leave’ vote.
The first and very significant economic shock from the result has been the reaction of the markets as investors have predominantly switched from UK stocks to foreign denominated stocks. There is also uncertainty surrounding British companies’ future willingness to invest and hire, resulting a sharp depreciation in the value of sterling which has lost a significant percentage of its pre-vote value. This depreciation will be good news for UK manufacturers in the short term as their goods have become cheaper for overseas buyers, however, the UK is a major importer of foreign goods which in turn have become more expensive. Manufacturers have weathered this storm in the first four months since the UK’s exit, however, there will be a limit to the extent to which this may continue. Therefore, currencies are supposed to be shock absorbers but if the value of sterling fell further, it will act not as a stabiliser, but as a source of shock (or aftershock) itself, and this is an important factor for the UK to consider.
Following sterling’s depreciation, it is hoped that UK residents would switch to domestic goods but this is not always the case. Much of the overseas goods are still demanded by UK residents which in turn will put pressure on prices in the long run. Depreciation induces ‘imported’ inflation and many economists have already forecasted the rate to be nearer 3 per cent by the end of 2017 – this being above the government’s 2 per cent target. But why is this an issue? Aside from unwanted above 2 per cent inflation rate, interest rates have been at historically low levels since April 2009 and moreover, the rate of borrowing was further reduced in August due to the slowing UK economic performance, and this is not set to change as the Bank of England announced cuts in growth forecasts from 2.3 per cent to 0.8 per cent next year.
So how can interest rates be used to control the onset of imported inflation whilst the Bank of England are still using measures to induce spending? With sterling set to depreciate even further and oil prices increasing the cost of raw materials to produce goods, the exchange rate’s secondary shock has created the onset of a series of aftershocks. Aftershocks are subsequent shocks related to the main (primary shock) and this is a major concern for the UK. Inflation is uncompetitive, and with the UK in negotiation following Brexit, one of the main reasons to leave was the persistent hiring of foreign workers at cheaper pay deals. After Brexit, whatever the terms of exit are, the wish of the British people was the discontinuation of this practice, however, the hiring of such workers has been key to Britain’s economy and in the economic aftershock state, with pressure on prices, this will be seen by many businesses as even more necessary.
A further related concern is the uncertainty of the free trade deal the UK wishes to pursue after Brexit. If the European Union refuses to sign a free trade deal, or at least a deal which allows the UK to maintain similar trade practices, this would initiate an aftershock as markets will react with even more vigour that the first post-Brexit wave. This deal is crucial for the UK as the reasoning amongst investors would be that the UK may not only be required to rejoin the trading queue, but will need to be prepared to climb even steeper to shake the same hands they shook prior to the 23rd June vote.
Dr. Victor Chukwuemeka
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