BNZ’s Chief Economist Tony Alexander on Brexit, and what’s to come
The vote by Britons last week to exit membership of the European Union has produced a substantial decline in the British pound and weakness in global sharemarkets. Do these rapid movements mean a global economic shock is underway? No. The financial markets had positioned themselves for a Remain victory so the result was a surprise and whenever a surprise hits the markets reaction can be violent as traders unwind bets taken on a different scenario. But on top of the markets getting it wrong there is extra weakness in many asset prices associated with the jump in uncertainty over what the impact will be on the UK economy.
In the short-term the effects will be negative as consumers cut back on their spending in a precautionary manner, and businesses weaken their hiring and investment just in case other businesses do the same. In other words, in the absence of any actual changes in the next couple of years over trade and migration rules between the UK and the EU, this is all about confidence for now.
Confidence among businesses and consumers is likely to remain depressed all the rest of this year in the UK but that does not mean financial markets remain weak. Asset prices always overshoot and at some stage perhaps this week we will see recoveries from oversold positions in sharemarkets and the British pound.
What are the implications for us here in New Zealand? As we have long warned, uncertainty offshore means interest rates are more likely to go down than up and we expect the Reserve Bank will cut the official cash rate from 2.25% to 2% in August. Additionally, and also as previously warned, this offshore uncertainty means we may not see any further increases in United States interest rates this year and rate cuts now seem likely in many other countries, possibly even the UK.
This means falling borrowing costs for Kiwis and further impetus to housing markets around the country – especially as even more long-term investors will purchase housing assets in their search for yield. Additionally, house prices may receive an extra fillip from fewer Kiwis going to the UK in the coming year and more coming back.
Low interest rates offshore mean, again as previously warned, a strong Kiwi dollar.
For NZ exporters there are clear risks for sheepmeat and wine sectors which send large quantities to the UK. However these risks mainly are relevant over two years from now when the UK actually leaves the EU and existing trade agreements get torn up.
NZ consumer and business confidence levels are likely to dip slightly in the short-term, but less so than in the UK and Europe given that since the UK entered the EEC in 1973 New Zealand has reduced its reliance upon the UK market to less than 4% of trade exports.
One factor we are keeping an eye on is bank funding markets in the UK and Europe. It is possible that as happened early this year we will once again see investors back away temporarily from their usual willingness to lend to banks and this could push funding costs up slightly. But the immediate impact of any rise in funding costs is likely to be limited as Australasian banks locked substantial funding into place earlier this year.
All up, there will be a slight negative global impact from the UK’s referendum decision which will extend the period of low interest rates while keeping NZ net migration flows high. The greatest impact however is in the political arena as the departure of the UK calls into question the nature and sustainability of the European Union and therefore the entire post-WW2 Western geopolitical framework.
At a time of assertion by China of its claims in the China Seas and expansion by Russia to the west this worrying development provides scope for new surprises which will themselves produce volatility in financial markets. Yet at the same time by keeping interest rates low for perhaps the next few decades and highlighting the “safe” remoteness of New Zealand net migration inflows look certain to stay high for many years – with obvious housing implications.