On the 23rd of June 2016, a referendum on whether to stay in the European Union or leave took place in the United Kingdom. The results were 48.11% of the people voted to stay in the European Union but 51.89% voted to leave the European Union. As a result of this, the United Kingdom is supposed to leave the European Union on the 29th of March 2019. However, no changes were immediately made after the vote and the United Kingdom will remain a part of the European Union and its single market rules until the withdrawal date. Economic behaviour depends not only on real economic changes but also on expected changes therefore the vote itself led already to a lot of changes in the economic situation of the United Kingdom.
Brexit will of course have a large impact on the economy of the United Kingdom as well as that of the European Union. However, the economic consequences of leaving the European Union will vary according to the policies the United Kingdom implements in the transition period. The transition period or as it is called by the British government the implementation period is supposed to last the 21 months following the Brexit day, hence from the 29th of March 2019 to the end of 2020. During this period, the United Kingdom is forced to abide by all the European Union’s rules but without having a say in the decision-making process.
Therefore, in this paper the likely effect of the Brexit on the inflation and the investment situation in the United Kingdom will be assessed in the months before the Brexit as well as in the 21 months following the Brexit to exemplify the impact of Brexit on the British economy.
Inflation and Interest rate:
The inflation level has increased sharply since the referendum; it was 0.4% in June 2016 and it reached 2.4% in November 2018.
The central bank of England wants to reach a target inflation of 2%. In order to ensure that inflation reaches the target of 2%, in the months leading to Brexit the Central Bank of England decided to increase the interest rate from 0.5 to 0.75 (Bankofengland.co.uk, 2018).
Brexit resulted in a depreciation of the sterling pound and this led to an increase in the cost of imports. Goods like food and clothes, those that have a high share of imports have been hit harder by the referendum than goods with lower share of imports. The prices of the goods that have a high share of imports have increased dramatically (Breinlich et al, 2017). This latter led to an increase in inflation. By June 2017, the referendum costed the British household around £7.74 a week though the increase in the prices. This increase in inflation is not accompanied by an increase in incomes hence this resulted in a decrease in real wages which resulted in a decrease in living standards in the months leading to Brexit.
The following graph shows even though there was a little wage increase in the labour market, the increase in the real wage fell after the Brexit referendum because inflation increased above the target of the Bank of England which is 2 per cent inflation. Prices rose above expectations and the increase in real wage was struggling to catch them.
The research done by the centre of economic performance’s analysis discovers that the United Kingdom is expected to have lesser trade because of the reduced integration of the United Kingdom with the European Union countries. This latter is expected to cost the United Kingdom’s economy much more than it used to gain from its assistances to the European Union’s budget. This is because the United Kingdom was part of a tariff-free trade area when it was in the single market of the European Union. This latter increased the trade between the United Kingdom and the countries in the European Union. The trade within the European Union benefited the United Kingdom as the cost of imports was low and as a result there was lower prices of goods and services. This latter led to a low level of inflation.
All the expectations and the forecast about the transition period depends on whether the United Kingdom will make a deal and leave the bloc smoothly or the United Kingdom and the European Union will not make a deal before the transition period. However, it is forecasted that in the case of a no-deal, when the United Kingdom leaves the European Union, hence in the months following the Brexit known as the transition period, the cost of imports is likely to increase hence the price of the goods and the services will increase and inflation will also increase.
Per a report done by the S&P, in the case of a no-deal Brexit, the economy of the United Kingdom will experience growing level of unemployment and a decreasing level of household incomes. These two combined would cause a recession to take place in the transition period. According to the S&P analysis, inflation might possibly be 4.7% in the middle of 2019 and it might reach a pic of more than 5% in the implementation period. The case of a no-deal Brexit is likely to occur specially after the opposition with Brussels over the deal post-Brexit.
On the other hand, it is forecasted by some optimistic people that if the British government makes a deal before the transition period, the inflation would decrease and reach the target of the Bank of England.
Investment:
Ever since the referendum, the expectations on the economy of the United Kingdom have changed. The level of uncertainty has grown as the future relationship between the United Kingdom and the European Union is still unclear. This latter is making it more risky for new businesses to invest in the United Kingdom. Hence, this will result in a low output growth.
Business investment is also a disappointing macroeconomic variable, the quantity of machinery, plants and new buildings have hardly grown in the United Kingdom since the European Union referendum.
Between March 2018 and May 2018, unemployment rate in the United Kingdom was 4% which is considered the lowest rate of unemployment in the United Kingdom since the 1970s. Hence, since the Brexit referendum the British labour market became stronger. This might be the only evident exception to all the other disappointing data. Not only did employment increase, but also the majority of this was in the full-time jobs as seen in the graph above. The number of people working in part-time jobs and the number of people in self-employment is decreasing moderately. Moreover, these numbers are offset by the increase in the increase in the full-time jobs. All this latter reduced concerns about people being underemployed. Normally, in an economy with full employment like this, the country is supposed to stimulate a lot of new business investment, because companies will adopt innovative technologies in order to keep growing without hiring new workers. This was the case in the United Kingdom until mid-decade, but ever since then, there was a combination of the decrease in the oil prices and the uncertainties due to the Scottish independence referendum in 2014, the election of 2015 and finally the European Union referendum in 2016. All these made companies think twice before obligating themselves to invest in the United Kingdom. Prior to the Brexit referendum, the Bank of England had predicted that business investment would increase more than 13 per cent in the two-year phase from 2016 to 2018.
The openness of the country to trade agreements, immigrants and new investments is expected to decline in the transition period. Hence, the United Kingdom is expected to attract less foreign investments. The imported goods will become more expensive which will increase the cost of living in the United Kingdom.
Trade barriers are expected to increase following the Brexit because of a possible disagreement in safety, packaging, health, and environmental ethics and standards. When the United Kingdom was a member of the European Union’s Single Market, it had to obey the European Union regulations and its products had to follow the mandatory standards to trade into any European Union country. After Brexit, it is possible that goods produced in the United Kingdom might not be traded in the European Union without a deal to accept the United Kingdom’s standards as like the European Union ones. Moreover, after Brexit it is expected that goods traded between the United Kingdom and the European Union will have to be checked by customs officials and a tax might be paid (Chote, 2018). It is expected that in the months following the Brexit (the transition period) there will be no confirmed trade agreement which will lead to higher prices caused by high tariffs. All of this will therefore, make investors think before investing in the United Kingdom until the end of the transition period. Investors normally like to have a big market. Hence, the majority of the investors will prefer to invest in the European Union than in the United Kingdom because this way they will have access to more than one country.
For example, Nissan the Japanese car manufacture has notified the British government that serious disturbance will happen to its enormous manufacturing operation in the United Kingdom if the United Kingdom fails to have a deal with the European Union that insures a smooth Brexit. According to the chair of Nissan, the operations of Nissan in the United Kingdom are viewed as a European investment in the United Kingdom. Nissan is based in the United Kingdom but it imports a lot of the European Union, hence if no-deal is made the car company will have to close in the United Kingdom and invest in any other country in the European Union (Conn, 2018).
If the United Kingdom leaves the European Union in March 2019 with a no deal; then in the months following Brexit, the United Kingdom would have to follow the European Union’s Common External Tariff when trading with any country in the European Union. The tariff rates in this situation is on average at low 4%.
Conclusion:
To conclude, the Brexit referendum impacted negatively the UK’s current and expected economic performance, it led to an instant devaluation of the British sterling pound. The referendum has already affected inflation and living standards in the United Kingdom. It was found that the referendum led to an increase in the prices of the goods especially the ones relying on imports in the months leading to the Brexit. It was also found that Brexit led to uncertainty in the economic environment of the United Kingdom which in turn resulted in a low level of new investments in the country. However, the expectations for the transition period depends on whether the United Kingdom will exit the European Union smoothly in a deal or a no-deal situation. However, all the current signals indicate a no-deal situation and this might harm the British economy as this might result in a higher inflation, higher unemployment, lower investments and lower growth rates.