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Wednesday, 19 June 2019

After Brexit, the game is 'wait and see'

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  • James Saft - June 2014

Central banks are joining companies in taking a “wait and see” strategy to manage the effects of Brexit.

Waiting for more information is one of those strategies which can work quite well if only a few people do it but has unfortunate side-effects if everyone waits at the same time.

The European Central Bank kept its policy stance unchanged on Thursday, noting that while the risks remained “tilted to the downside” it was too early to assess the fallout from Britain’s June 23 vote to leave the European Union. The ECB thus got in line behind the Bank of England, which last week also decided to wait.

The BOE held fire while at the same time signalling that it would likely ease in August.

Even the Bank of Japan, which 85% of polled analysts expect to loosen when it meets July 28–29, may choose to wait, in its case, according to a Reuters report, because it hopes momentum is building in the jobs market. The Fed too is almost certain to hold fire at its July policy meeting, though its next move is generally expected to be a rate hike sometime next year.

That central banks would be pausing in the aftermath of Brexit is, on the face of it, puzzling.

There is extremely broad agreement that, although Brexit’s effects will be complex and long-lasting, the direction of travel will generally be downward. The IMF this week downgraded both its global and UK growth forecasts, while warning that the damage could be worse than expected if trade and markets don’t cooperate. Britain’s vote may not just impair trade relations but also signal a new mood among western electorates, one more hostile to free trade and impatient with the status quo. That’s apparent both in the US presidential election and in the eurozone, where increased Brexit-like sentiment and votes may be a risk.

The IMF took its global growth forecast down by 0.1 percentage point to 3.4% for 2017 while slashing Britain’s outlook to 1.3% growth from 2.2%.

Thus far financial markets have remained relatively calm about Brexit, with the pound hit but stocks generally firm. Bond yields have fallen, reflecting a gloomier outlook for growth and inflation.

Looking round corners

As for the real economy, Brexit is also causing individuals and businesses to hold off on investments and projects, a phenomenon which can only be reversed much more slowly than a central bank decision.

British job search engine Adzuna reports that in the week to July 8 there were 25% fewer new jobs than in the first week of June, before the referendum, and one in six property listings on UK website Zoopla had their price cut in the 17 days after the vote, amid widespread reports of buyers pulling out of deals.

The Royal Institution of Chartered Surveyors on Thursday reported that investment enquiries for commercial property fell last month to their lowest since the recession year of 2009.

As property, particularly commercial, often leads the cycle in Britain, these are significant data points.

Outside of real estate and the job market, the tea leaves for investment in the UK are, if anything, even less encouraging. A survey by accountants Deloitte of chief financial officers from large private and publicly traded UK companies found 82% expect to cut capital spending in the coming 12 months, a record proportion. Who would invest heavily into a landscape with as much uncertainty as Britain’s?

This all makes a compelling case for a UK monetary stimulus, and that it seems we will get in August.

What though might be behind the reluctance to act among other central banks? Perhaps things are not quite so bad in the global economy and Brexit will just be an unhappy local story. Perhaps instead central banks are not confident that the steps they may take, either quantitative easing or lower interest rates, will be effective.

Given the price action in large European and British banks after Brexit, which implied lower interest rates, it is increasingly clear that very low and especially negative rates pose an existential threat to the banking business model. With rates in negative territory in the eurozone and Japan and just barely positive in Britain and the US, this is a problem.

Remember too that the placid reaction in financial markets to Brexit was largely driven by expectations of policy-maker safety nets, not a reassessment of the actual damage.

If everyone waits at the same time no one may like the outcome.

(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)

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