Schadenfreude over British exit
Why Europe’s post-Brexit performance may be worse
by David Marsh
Mon 11 Jul 2016
The fortnight after the UK’s anti-European Union vote has been a poor advertisement for Britain’s crisis management prowess. European central bankers are displaying Schadenfreude about the sharp fall in sterling and chaotic state of UK politics.
The view in Frankfurt, home of the European Central Bank, is that the referendum aftermath, including a retreat from the front line by Prime Minister David Cameron and his two former principal rivals for the job, is a powerful antidote to other European parties considering similar plebiscites.
However, other Europeans should be careful not to gloat. The quicker-than-expected resolution of doubt about the next leader of the Conservative party and prime minister – it will be (by Wednesday evening) Theresa May, the home secretary, after Andrea Leadsom, the other candidate, pulled out today – shows how the clock can speed up, potentially in Britain’s favour. In a few years, the UK may be pleased that it got its referendum in early.
Yes, Britain faces uncertainty as it redefines its economic and political future.
Yes, the performance of Leave campaigners chronically unprepared for an unexpected victory has been abject.
Yes, George Osborne, Britain’s pro-EU chancellor of the exchequer, has predictably reneged on his ill-advised pre-referendum announcement of a contractionary post-Brexit budget – a threat (correctly) labelled as ‘absurd’ last week by Mervyn King, former governor of the Bank of England.
Boris Johnson, the pro-Brexit former mayor of London, has displayed such a level of recklessness that even the Conservative party may think twice in future about proposing him for high office.
Yet, compared with the tests awaiting the rest of the EU over the next 15 months – from the repercussions over Italy’s go-it-alone bank rescue plan to electoral tussles in Italy, Austria, the Netherlands, France and Germany – Britain’s travails may turn out to be relatively harmless.
Much depends on how smoothly May begins formulating strategy and starting exit negotiations. If the UK relatively soon has a reasonably solid government, we could witness a rerun of the aftermath of the Lehman Brothers bankruptcy in September 2008. The euro showed resilience in the months afterwards, while sterling plunged – only for the positions to be reversed later on as the full impact of the euro peripheral members’ debt crisis hit home.
Sterling’s trade-weighted index has fallen by around 11% since the 23 June vote, but is still only marginally below levels three years ago that the Bank of England regarded as appropriate at the time. Between May 2013 and May 2016, sterling’s real (inflation-adjusted) index rose 7%, against a fall of 4% for the euro, and rises of 16%, 8% and 3% for the dollar, renminbi and yen respectively.
The pound’s fall, although made more dramatic by the EU vote, has hence been in large part a correction to a previous overvaluation. The question now is when the dollar will start to fall again, although this will probably be delayed until some time after a new US president takes office.
The euro’s post-23 June rise against sterling (weakening the euro bloc’s competiveness against its most important trading partner) and a decline in European growth prospects are bad news for European economies. European central bankers are starting to talk of an extension of the ECB’s quantitative easing beyond the previous cut-off point of March 2017 (and even a further increase in monthly bond-buying despite the difficulty of accomplishing present purchase quotas). If this is necessary, then the ECB’s QE, highly unpopular in the Netherlands and Germany, will become an even more virulent topic in both countries’ parliamentary elections next year.
For the UK, one comforting aspect is the strength of foreign investor demand for sterling assets, including government bonds, at now much cheaper levels. The UK still has access to plentiful ‘kindness of strangers’, the quaint term Mark Carney, governor of the Bank of England, used in January to describe foreigners’ propensity to fund the UK’s large current account deficit.
I am indebted to Patrick Honohan, former governor of the Central Bank of Ireland, for pointing out that the phrase stems from the parting lines of tragic heroine Blanche DuBois in Tennessee Williams’ A Streetcar named Desire. Honohan opines: ‘Let's hope the sad and chaotic life story of Blanche is not mirrored in the future of the UK economy.’
When she utters those words, Blanche is being guided to a mental hospital by a kindly doctor. There must be hope that Britain’s outlook is slightly healthier.
David Marsh is Managing Director of OMFIF.
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