Brexit at Two Months: A Slow Burn in European Integration
Robert Kahn, Steven A. Tananbaum Senior Fellow for International Economics
Bottom Line: Markets have absorbed the initial economic shock from Brexit, but navigating the new landscape will remain a challenge. Two months after the vote, the politics of Brexit is producing a lengthy and uncertain renegotiation of Britain’s place in Europe and the world. Such extended uncertainty is likely to produce a long-lasting drag on both UK and European economies, which could ultimately threaten the viability of the European Union (EU).
Brexit at Two Months
The June 23 Brexit vote was not a “Lehman moment,” as some analysts had feared. That it did not cause a financial market freeze similar to what followed the fall of Lehman Brothers in August 2008 is a result of the strong central bank action to calm markets and subsequent monetary easing from the Bank of England. Markets have stabilized and the recent economic data has been solid, leading many market analysts to declare the crisis over.
Such optimism is premature. For the United Kingdom, which before the vote was expected to grow at 2 percent annually, the damage to growth still could be severe, perhaps on the order of 2 to 3 percent of gross domestic product over the next eighteen months. This contraction reflects the substantial political and economic uncertainty created by Brexit and its likely effect on investment and consumer demand. The exchange rate depreciation and easy monetary policy will provide a powerful offsetting boost, but it will take time to be felt. The United Kingdom remains on the front line of this event.
The more difficult question is the extent of contagion to the rest of the world and in particular Europe, given the EU’s weak economy and its population’s increasing frustration with its economic prospects. As in the United Kingdom, uncertainty about post-Brexit relations is likely to weigh powerfully on investment throughout Europe. Financial stability is also an issue: European bank stocks continue to underperform and the continental banking system is struggling with the legacy of the crisis and weak profitability. Lower interest rates will not help on that latter score. The European Central Bank can ensure adequate liquidity to troubled banks, but it cannot make them lend. If Europe wants above-trend growth in this environment, fiscal policy will need to do more.
Looking ahead, I see two systemic market risks coming out of Brexit. The first is the potential for lengthy negotiations to extend the exit process at a significant economic cost for markets that crave certainty. This tension is the result of a disconnect between economic and political timelines. The second risk is that it will distort decision-making by European policymakers on critical economic questions. Although many of Europe’s challenges would have presented thorny problems absent Brexit, the UK vote creates a low-growth, populist environment in which decision-making will be even more difficult. Consider each of these drivers in turn.
A Disconnect Between Political and Economic Timelines
Immediately after forming her government, UK Prime Minister Theresa May announced her intention to trigger Article 50 at the end of 2016, beginning the formal process of Britain exiting the EU. Now, there are reports that invoking Article 50 may be delayed until the end of 2017 and a formal exit delayed until the end of 2019. Read more »