The UK is currently in a period of intense uncertainty, with political leaders, commentators and the wider population unsure when and how article 50 will be triggered. With 52% of voters opting to leave the European Union (EU), economists are speculating over the impact of this decision on the UK’s businesses and economy.
Following the referendum, the world’s three main credit rating agencies – Moody’s, S&P and Fitch – downgraded the UK’s credit rating, meaning the country finally lost its AAA status.
There are a number of reasons why the UK’s credit downgrade matters. Although it is unlikely to affect appetite for Treasury debt in the short term, S&P and Fitch are both on standby to potentially downgrade the UK further.
Should this happen, and UK government debt loses its investment grade status, UK gilts may be excluded from the safest portion of investment portfolios, reducing demand and raising the government’s borrowing costs.
The impact of Brexit on other forms of borrowing remains to be seen. In order to stimulate inflation, it’s highly likely the central bank will further reduce interest rates before the end of the year which should, in theory, ease the cost of borrowing.
Yet economists and investors have raised concerns about a rise in the cost of borrowing for companies and consumers, even if the Bank of England’s base rate goes down. This is
because the wider economic uncertainty triggered by the Brexit vote may mean lenders increase borrowing costs to offset the greater risk of lending in the UK.
Higher borrowing costs will have a negative effect on businesses, particularly if the economy enters into a recession.
In the immediate aftermath of the referendum, the markets were understandably volatile. Sterling plunged to a 31-year low while the FTSE 250 – generally considered a better indication of UK business than the FTSE 100 – reached a 52-week low of 14,951.46.
The UK’s biggest companies had £40 billion wiped off their value, with Barclays and RBS suffering such a significant fall in share price that trading was automatically halted.
While a weak pound would, in theory, benefit UK exports, many financial experts aren’t convinced. For a start, the UK relies far more on imports than exports. Furthermore, Neville Hill of Credit Suisse explains that, as UK manufacturing and service exports are high-value-added, they are more sensitive to changes in demand than changes in price.
Around 28% of UK produce is sold abroad, with 45% of that figure exported to EU countries. With the UK’s access to the single market currently uncertain, European demand will likely be impacted. This compounds already-weak demand in most emerging markets, which means the lower pound may benefit the economy less than expected. Indeed, the UK’s economy is likely to feel the squeeze over higher import prices more strongly than any relief caused by a boost to exports.
Adding further concern, the EU could now impose a tariff and quota for UK exports to Europe, limiting the amount of goods and service sold.
Financial and professional services contribute to around 12% of the UK’s GDP. The financial sector alone provides vital support for the economy and employs more than one million people.
Following the Brexit vote, the head of the European Central Bank said London could lose its status as Europe’s financial capital, and media reports have suggested there could be a significant relocation of financial services jobs to Europe.
Trade body TheCityUK commissioned a report by PwC suggesting that an EU exit could put up to 100,000 financial services jobs at risk. Banks may lose their ability to advise on European deals or sell euro-denominated products if we don’t retain access to the single market. In turn, this could prompt a move to EU cities such as Paris, Frankfurt and Dublin.
The outlook for the UK’s businesses and economy is currently uncertain, with so much depending on the strength of negotiations around a UK exit from the EU. Business secretary Sajid Javid emphasised that keeping the UK’s access to the single market must be the biggest priority in EU negotiations. Whether that will be possible remains to be seen.