Brexit Makes Investors Nervous, But U.K. Recession Isn't Certain

Jun 28, 2016
Originally published on June 28, 2016 7:57 pm

Last week's Brexit vote sent financial markets tumbling around the world, wiping out months of stock market gains and pushing the British pound down to levels not seen in more than three decades.

It also raised tough questions about the future of the United Kingdom's economy, especially with the resignation of Prime Minister David Cameron and the ensuing political turmoil.

"Nobody quite knows what sort of government's going to come in, and that uncertainty absolutely discourages consumer spending, discourages investment. So the chance of a recession is substantially increased by this," says Simon Johnson, professor of entrepreneurship at the Massachusetts Institute of Technology and a senior fellow at the Peterson Institute for International Economics.

About 30 percent of the U.K.'s economy is tied to exports, much of it in services, and almost half of that goes to the European Union. After Thursday's referendum supporting an exit from the EU, exports are expected to take a hit.

"There are potentially some issues over standardization and continuing to conform to European regulations, and there are issues in terms whether tariffs would be applied as well to certain goods," says Andrew Goodwin, chief U.K. economist at Oxford Economics. "The level of tariffs varies quite considerably across different sectors. So there are lots of issues about how we can actually trade with the EU going forward, if we don't have a formal free-trade agreement."

Before the vote, the U.K. economy was growing at an annual rate of little more than 2 percent a year. While much of Europe is just emerging from a long period of deflation and high unemployment, the U.K. has held its own.

"I would hesitate to call it a boom, but the economy is certainly considerably more robust than most of their European Union partners," Johnson says.

Helping to fuel the growth has been a large wave of foreign money from China, Russia, the Middle East and elsewhere. Investors have been attracted to Britain because of its stable government and its role as an international financial capital. Meanwhile, its membership in the EU allowed companies access to the enormous European market.

Last week's vote could stem the flow of foreign investment. Goodwin doesn't believe the U.K. will fall into recession but he estimates that annual growth could fall to 1.4 percent through next year.

"We acknowledge that companies are very nervous and they will be quite reticent about investing and committing to big investment plans while there's so much uncertainty. However, we don't think the impact on the consumer sector will be quite as large," he says. Continued consumer spending should offset some of the negative effects of the Brexit vote, he says.

The vote will probably lower growth somewhat, but the impact will be limited, says Thomas Simons, a money market economist at Jefferies and Co.

"We wouldn't see a huge decline in activity. Rather we would see a more cautious tone for their business investment overall," he says.

"The other thing to keep in mind is that although the U.K. voters have said they want to leave the EU, they are still in it right now. So all the current trade agreements are still in place and business will continue as usual, it's just that investment for future activity will decline."

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ROBERT SIEGEL, HOST:

People in the U.K. are also worried about their economy now that they're leaving the European Union. Many, though not all, economists are predicting that the country will now enter a recession. NPR's Jim Zarroli reports.

JIM ZARROLI, BYLINE: Before last Thursday, the U.K.'s economy appeared to be fairing pretty well. While much of Europe is just emerging from a long period of deflation and recession, growth in Britain exceeds 2 percent. Simon Johnson is a professor of entrepreneurship at MIT.

SIMON JOHNSON: I would hesitate to call it a boom, but the economy is certainly considerably more robust than most of their European Union partners.

ZARROLI: The Brexit vote changed everything. Almost immediately, the British pound fell sharply, stocks lost ground and the major credit rating agencies lowered the rating on U.K. government debt.

Leaving the EU threatens to knock out one of the underpinnings of British growth. Thirty percent of the U.K.'s economy is made up of exports and almost half of them go to EU countries. Andrew Goodwin is chief U.K. economist at Oxford Economics.

ANDREW GOODWIN: So there are lots of issues about - sort of about how we can actually trade with the EU going forwards if we don't have a formal free-trade agreement.

ZARROLI: One of the leaders of the Brexit campaign Nigel Farage says the U.K. faces a recession with or without the EU. The uncertainty has only grown worse because of the political turmoil in Britain and the open question of who will lead it when Prime Minister David Cameron steps down, says Simon Johnson.

JOHNSON: Nobody quite knows what sort of government's going to come in. And that uncertainty absolutely discourages consumer spending, discourages investment, so the chance of recession is substantially increased by this.

ZARROLI: But Andrew Goodwin is a bit more sanguine, at least in the near term. Goodwin says the uncertainty about the U.K.'s future means it will attract less foreign investment, and he thinks growth will slow to about 1.4 percent through next year. But he doesn't think a recession is imminent.

GOODWIN: We acknowledge that companies are very nervous and that they will be quite reticent about investing and committing to big investment plans while there's so much uncertainty. However, we don't think the impacts on the consumer sector will be quite as large.

ZARROLI: For now, the U.K. is still part of the EU, and at least for a while business will continue as usual, says Thomas Simons, chief money market economist at Jefferies and Company. Simons says the longer the uncertainty continues, the less investment the U.K. will attract. But he also says as long as the EU survives and the U.K. can clarify its legal and political ties to the rest of Europe, it could eventually find its footing.

THOMAS SIMONS: Outside of the EU, they'll actually have fewer restrictions and regulations that are part of their businesses by people outside of the U.K. So they can make policies that better suit their overall business needs which should be beneficial for the economy in the long run.

ZARROLI: But right now there's considerable pessimism about whether that can happen, and the financial markets have been reflecting that. The Bank of England is doing what it can to reassure investors. Bank officials are expected to meet next month and cut interest rates. There's not much room to cut since rates are already very low. But doing so could send a message to the markets that officials are at least doing something. Jim Zarroli, NPR News. Transcript provided by NPR, Copyright NPR.