The Rearview Mirror – July 2016

The Rearview Mirror
The Rearview Mirror

Christian Zorico (162)




bridge_by_motowncinderellaJust a week after the UK sent an unequivocal shocking message to the world by voting to leave the EU with a margin of 1m+ votes, market behaviour has done a 180-degree turn. In the end, after the vote, Friday and Monday equity sell-off was a buying opportunity. Indeed investors should ask themselves the reason why although major stock market have massively rebounded, government bond yields touched new lows, suggesting that policy makers are willing to be very accommodative for the upcoming future. We cannot doubt that BOE is called to sustain its economy, i.e. the Pound reaction is a logical proof. Again ECB should offset the negative impact on its GDP due to the BREXIT by using a more market-friendly policy. But what about Federal Reserve? Are we sure enough that the market is consciously reading the FED activity?

In the following lines we are going to have a better understanding of some economic and social implications of the UK referendum by reading the contribute of  Dr Antonio Mele, lecturer in Economics, University of Surrey. Antonio’s research interests are in macroeconomics, fiscal and monetary policy: international risk sharing with moral hazard is the theme of one of his working papers. I give thanks to Antonio for having accepted this interview and moreover for his readiness and geniality to offer his view to the “Rear View Mirror” readers.

Antonio Mele, Lecturer in Economics, University of Surrey.
Antonio Mele, Lecturer in Economics, University of Surrey.

Hi Antonio, you acted together with other professors to help people to be more informed about the risks behind the decision to Leave the EU. Now we can easily understand, by analyzing latest official declarations, that even bureaucrats have no material exit strategy plans. Is it only a problem of information set? 

I think politicians campaigning for Brexit never thought that Leave will win. They were focusing on internal political issues, namely the Tories’ leadership, and pushing an anti-immigration agenda that speaks to that part of the electorate that lost the globalization race (unskilled, working class, living in rural England). Unfortunately for them, and for the United Kingdom, they won.

By looking at the composition of the vote, both England and Wales have voted to Leave, overriding clear Remain votes in Scotland and Northern Ireland. Regionally speaking and from a demographic point of view, the picture of the vote was very mixed. Do you believe that the opposite result, ie. Remain 52% against Leave at 48% would have changed the perception of the reality? Are you concerned about the future of the European Union as we are going to approach to a new season of political tests?

My feeling is that the referendum was very polarizing in terms of opinions. I would say that two types of voters supported the Leave option: those that are optimistically deluded into believing that UK without the EU will be magically transformed into a free trade, laissez faire paradise; and those who instead are voting out because of migration issues, even unrelated to EU migrants per se. The first group is probably quite small, with the major component being constituted by the second group. However, a common characteristic is that both these socio-demographic groups are very difficult to convince based on facts and empirical evidence.

BrexitCan you briefly give us your opinion about potential negative effects on UK economy? What about repercussions on EU and on US GDP? The market has basically declared that the Fed cycle is over. The US yield curve is suggesting us that we are starting to see some rate hikes priced in for 2018. Do you believe that at this stage, the Chairman Yellen should focus the monetary policy by taking into account the Brexit vote or there are still opportunities to see a rate hike during 2016?

I am not sure we should make strong claims at the moment. The only certainty is the uncertainty in front of us: markets are already reflecting this. I would expect most firms with a presence in UK to delay or cancel investments for the next few quarters, and to freeze hire. Most of the independent economic institutions calculated GDP losses for the current year in the order of 2-3% with respect to baseline before the referendum. Most of those losses are believed to be permanent, and I firmly believe this is the most likely scenario. The claim of the Leave leaders is that, if the transition leads to a UK that is more competitive and with growing productivity, with better immigration laws, etc. those losses can be overturn. In light of the characteristics of the constituency that voted for Brexit, I would not bet on the latter scenario. I am pretty sure that every decent economist is making the same analysis right now, including Janet Yellen. The risks for EU are more subtle: if Brexit is successful, this will give momentum to all those political local forces that are pushing for the same result in the rest of Europe (Podemos, 5 Stars Movement, Le Pen, etc.). A balcanization of the European project is likely in that case. The EU has therefore all the interest in making the Brexit outcome the worst possible for UK, even at the cost of causing a recession in Europe in the process. Again, it is difficult to say anything solid now in an environment that changes day by day, but at the moment the most likely scenario is a tough EU against UK.

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