Brexit: assessing the impact on the economy

15 Jul 16

The UK’s vote to leave the European Union created a mix of impacts across the economy. It is vital in the months ahead policymakers and business work together to meet these challenges

The starting point for any analysis of how the economy has responded to Brexit is to consider how the economy faring in the run up to the vote? The short answer is “reasonably well”. Unemployment has fallen to 5%, its lowest since 2005, and the economy grew by 2.3% in 2015 - second fastest in the G7, narrowly behind the US. Admittedly, there had been a slight softening in UK growth in the first quarter of this year – coming in at 0.4% quarter-on-quarter – but this is still a reasonable growth rate given that referendum uncertainty was likely creating a drag.

Moreover, many of the shortcomings in the run up to the financial crisis are not evident now. Banks are much better capitalised, credit conditions are good, and – as the governor of the Bank of England has set out – the major banks have passed “stress test” scenarios far more severe than the challenges they currently face.

Households have been deleveraging steadily since the crisis, and corporate profitability is strong.

However, there are some indicators that need close monitoring, such as productivity growth – which has all but flat-lined since the financial crisis – but which is the single most important driver of sustainable growth, public finances, prosperity and living standards over the longer term.

Secondly, the current account deficit, which reached record levels of 7% of gross domestic product earlier this year, emphasises the importance of the UK remaining “open for business”. The weakening of Sterling since the referendum is likely to boost UK exports over time, as foreigners find it cheaper to “buy British”, and UK investments overseas will immediately be worth more in pounds.

It is too early to say where we are now - after all, the short-term economic impact of the referendum result will depend very much on the impact on confidence and expectations for consumers and businesses.

There have been some initial litmus tests. The GfK Consumer Confidence Barometer, released last week, showed the largest decline in consumer confidence since 1994 – but this was fielded in the period 30 June to 5 July, possibly reflecting post-vote emotions that have subsequently settled.

Data over the coming weeks and months will give us a better guide as to the scale and type of economic adjustment following the vote, which is why we at the CBI have been speaking to hundreds of our business members, picking up a real mix of impacts.

For many, the uncertainty has caused investment decisions to be shelved, or hiring decisions to be reassessed. For some, a weaker pound supports their exports. For others, the exchange rate has mixed effects depending on whether sales and costs are in pounds or foreign currencies.

Understanding what is happening on the ground – on factory floors, in offices and in supermarkets – will lead to more targeted and effective policy.

While the Bank of England’s monetary policy committee has decided to keep rates on hold this month, governor Carney has made clear the committee stands ready to loosen monetary policy in the coming months. This will undoubtedly help to ease economic conditions for households and businesses, with borrowing rates at record lows. But lower rates are likely to create losers as well as winners. Banks will find it even harder to turn a profit in a world of even lower – or perhaps negative – rates, with implications for the supply of credit to the real economy. If the Bank of England chooses to “look through” the impact of a weaker pound on inflation – which is likely to run higher as imports become more expensive – that will erode the purchasing power of consumers in the shops and push up the costs faced by business when importing goods.

With interest rates at record lows, fiscal policy also plays an important role in shoring up business and consumer confidence. Over the long term, balanced and sustainable public finances breed confidence, and this should not be forgotten. But in the short-to-medium term fiscal policy should take account of the state of the economy.

Theresa May suggests she will no longer seek to balance the public finances by the end of the Parliament, releasing the government from a target that was already looking challenging. Now more than ever, it is essential that there is a strong dialogue between policymakers and business, to ensure any measures target the specific challenges facing firms of all sizes.

 • This article is based on a speech Rob Fontana-Reval gave to this syear's CIPFA conference in Manchester.

  • The UK’s vote to leave the European Union created a mix of impacts across the economy. It is vital in the months ahead policymakers and business work together to meet these challenges.
    Rob Fontana-Reval

    Rob Fontana-Reval is the CBI’s head of economic and fiscal policy, fronting the CBI on economic, tax and fiscal issues on behalf of its members, setting the CBI stance on fiscal policy, and leading submissions and engaging with government ministers and senior officials ahead of Budgets, Autumn Statements and Spending Reviews

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