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Why the Brexit is Such a Big Deal for the World

Countries within Europe have suffered a major decrease in economic alliances with each other. And this is happening in a region that is already plagued by slow growth. The Bank of England said on Friday morning, “We are well prepared for this.” It will likely cut its main interest rate (currently 0.5%) and even revive its quantitative easing efforts. Nonetheless, a recession in England certainly seems likely. 

Because an event like the Brexit has never happened before, the fallout is extremely difficult to forecast. But here is an attempt to see how it will affect the U.K. (For related reading, see: Brexit: What Lies Ahead.

In the Brexit Vote Aftermath

U.K. corporate investment will slow due to the uncertainty of the future between the U.K. and EU. The U.K. has participated on trade deals which have been negotiated by the EU. The future of those deals is now in question. 

Consumer spending will also slow as recession fears mount and as the British pound collapses. The collapsing pound might also drive up inflation, which would also hurt real income rates. 

The U.K. unemployment rate will grow as companies seek to limit spending and to shore up balance sheets

The European economy will also likely slow, possibly contracting into negative rates as the EU copes with a departing U.K. Though, the reduction in GDP growth will likely not be as severe as in the U.K. 

How the rest of the world will be impacted by a Brexit is much more complicated. The world economy is already fragile, so the risks are real. Here are some guesses as to how things might play out. (For related reading, see: The Upside of a Flat Market.)

Impact on the Rest of the World 

Southern European countries will see bond spreads rise as the risk for further EU exits mount. A weaker Europe will hurt Chinese exports as European currencies weaken and as consumer demand softens. The Chinese Yuan will likely fall in anticipation of this new possibility. The U.S. dollar will strengthen on weakening European and Chinese currencies and on the falling probability of a Federal Reserve interest rate hike

Also, oil prices will likely feel downward pressure on lower demand and a stronger dollar. 

Because there is so much uncertainty regarding the future of the U.K. and the EU, market volatility will certainly remain high. How quickly the U.K. and the EU negotiates a trade deal will help alleviate market concern and volatility. If a deal is passed relatively quickly, the damage can be (theoretically) minimized. However, the markets immediately following the new have indicated that this might not be the case. Furthermore, if Britain is able to execute a favorable trade agreement in a short amount of time, might not other countries in the EU likely attempt to do the same? And isn’t this what the EU hopes doesn’t happen? (For related reading, see: A Market Barometer: Corporate Earnings.)

A Wake-Up Call for Elected Officials

More than anything, the Brexit should be seen as a wake-up call to all western elected officials. Rising inequality and low growth promotes frustration among its citizens. Brexit represents the division between the politician’s hopes for what the majority of people should do and what the majority of people are willing to do.

So far, central bank intervention (e.g. U.S. Federal Reserve, European Central Bank, etc.) has been the primary driver of economic growth. There has been little, if any, positive contribution from elected officials. This, or course, is not sustainable. Politicians need to take the necessary steps to promote higher growth. And these steps should include the majority of its people, not just a selected segment. Otherwise, similar (and seemingly improbable) events like Brexit are sure to occur again. (For related reading, see: How the Brexit Could Impact U.S. Investors.)