The UK’s approach to financial crime has taken a turn for the better recently. The successful prosecutions in the LIBOR-rigging scandal are a signal that British authorities are coming close to their US peers in slapping down errant bankers. The trouble is, there is pressure to take the foot off the pedal.
Not only has the new boss of the City watchdog suggested that banks should be keeping their own houses in order, the threat of Brexit opens up the possibility that the UK will have to fight to maintain the primacy of London as a financial centre. If that effort leads to a softening of the controls on the banks and bankers, it would be a grave mistake.
London is currently listed as the top financial capital in the world. Its main strengths are stability and dynamism. Effective regulatory and enforcement regimes can promote trust and confidence from the public, which helps to underpin that financial stability.
Given the role of banks in the global financial crisis, it is a dangerous time to soften controls, even if the pressure from the industry is ever present. There is a clear risk that some bankers will return to prioritising profit at the expense of customers and ultimately, at the expense of the wider economy. That would suit no one in the capital and beyond over the long term.
Motivation
Brexit though, has upset the apple cart. The US watchdog for monitoring financial stability, the US Office for Financial Research recently said that political and financial uncertainties caused by Brexit may last for months or even years. That leaves the financial industry in flux.
In effect, UK voters’ decision to leave the European Union gives a potential opportunity for countries such as France, Germany and Luxembourg to strengthen their positions as international financial centres. The most immediate concern is whether banks will be able to sell financial products and services from London to customers in Europe when Brexit takes place. Bullish noises from politicians may not be enough to convince banking executives that their strategic decision should be left to the whim of EU negotiators.
London will fight to stay competitive, but the focus should be a determination for regulators, politicians and investigators to maintain their improving proactive and robust styles. A race to the bottom on oversight would be potentially dangerous. It would leave the door open to fresh scandals; even a fresh crisis. It is hugely important that the new chancellor of the exchequer, Philip Hammond, leads a tough regulatory approach.
You see, an effective, efficient and enforced regulatory regime can be a competitive advantage. Australia and Canada both emerged better than the UK from the global financial crisis. One of the many reasons is that the regulators in Australia and Canada were more proactive and robust in monitoring and supervising their banks.
In the UK, the Bank of England’s report into the failure of the Financial Supervisory Authority (predecessor of the current watchdog, the Financial Conduct Authority) found that there were inadequate resources. This affected the authority’s ability to supervise banks such as HBOS. Simply put, you need sufficient resources (both human and financial) to enable the various authorities to perform their jobs effectively.
Taking the lead
The Financial Conduct Authority (FCA) is the regulator for the financial sector. It sets guidelines, monitors behaviour and can stop people from operating in the industry if they break its rules. Its remit is to protect consumers, and it did so with a budget of £479m in 2015-16 and £452m in 2014-15.
That is already more than the budgets of equivalent bodies in Germany and in the US. But while it is encouraging that the FCA is well funded relative to its peers, it is also a worry that policy makers might see this as fat that can be trimmed.
I believe the funding levels for the UK regulator should actually be boosted as it seeks to rubber-stamp Britain’s reputation in the face of threats to the financial sector, and a change to the law would do it.
Until 2012, regulators were able to use the fines collected from banks to fund their work. However, the then chancellor, George Osborne, changed the law to draw the fine revenues into the Treasury. Under Osborne’s control, armed forces charities and the emergency services received the fines, not the authorities which had imposed them.
Clearly, these charities and services perform very important roles in society but a boost to the budget for policing financial crime would help society in its own and important way, while helping London to maintain that competitive edge. Although fines against individuals by the FCA have declined in recent years, the new senior managers regime, designed to improve individual accountability, may reverse this trend.
As old investigations close – some with success – it is vital that there are the resources and support to start new investigations. The UK has the largest financial services sector in the European Union, at least for now: if it is to grow sustainably, to support a post-Brexit economy, then oversight and enforcement must be stronger than ever.
Author: Alison Lui, Senior Lecturer in Law, Liverpool John Moores University
Britain’s housing market is in a sorry state. With house prices forecast to fall, house building grinding to a halt and buyers pulling out of purchases amid job security fears, post-Brexit uncertainty has been worsened by the contrasting “visions” that won the vote.
These opposing visions are now evenly represented in Theresa May’s cabinet. The more liberal Leave campaign wanted greater economic freedom, with less government and “Brussels bureaucracy”. Its supporters have quickly retreated from any pledge to bring down immigration, which would compromise access to the EU single market.
The others in the Leave side, however, are happier to resist market forces, even accepting some short term sacrifice of living standards to restore “sovereignty”, and a sense of community they view as eroded by too much free movement. For these “grassroots” Leavers, concerned about social cohesion and quality of life, lower house prices are a key Brexit bonus. Controls on arrivals from the EU and strict barriers against refugees are intended, in part, to reduce the demand for homes and related public services.
This could, in turn, make housing more affordable to existing residents, with wages rising as fewer compete for available jobs. And if the economy slows, interest rates will fall further, potentially improving mortgage affordability.
Will Brexit lead to a buyers market?Toby Melville/PA Archive/Press Association Images
Houses could well become easier to buy if, as both factions promised, average incomes now rise due to “unshackled enterprise” and less competition for jobs. Those pursuing homes to live in may also find there are fewer rival buyers treating property as just another investment. Rule changes in April had already quelled buy-to-let demand. Absentee foreign buyers who had inflated prices in and near London might now look to buy in other capitals that will remain within the EU.
Making housing more expensive has been central to economic recovery strategy since 2010. This is because rising prices benefit homeowners, who are still a large majority of voters. Many younger voters priced out of the market will now hope that affordable housing can be part of May’s version of Conservatism. But while her swift installation might dispel the uncertainty that stalled pre-referendum investment – including housing starts – her new economic plans will have to rule out a sustained drop in prices, as this would hit household spending too hard at a time when other sources of demand are also weakening.
Households are already approaching a level of borrowing which proved unsustainable before 2008. So longer-term house price growth is unlikely to exceed national income growth, which most forecasters calculate will slow down as the UK starts its slow path out of the EU.
And even if Brexit does not restrain production and income growth, it is likely to weaken house buying demand by hitting the profitability of banks, whose recovery from crisis is still being slowed by tougher regulation, new entry and alternative forms of business borrowing.
So while many landlords suspect that Brexit will end the long escalation of housing costs both for buyers and renters, this is unlikely to make it any easier for the average household to find an affordable home.
The housing market has felt the immediate effect of Brexit chill.David Cheskin/PA Archive/Press Association Images
This is because although rising investment might speed up residential building and renovation, it would leave house builders vying for resources with commercial construction and other industries – even if the general labour supply is not constrained by lower immigration.
In short supply
The long run up in house prices reflects a chronic failure to build enough new homes, often traced to restrictive planning laws that reflect local concerns much more than eurocratic meddling.
To ensure profit, developers always have an incentive to release new homes more slowly than the market needs them. And neither local authorities nor housing associations are currently able to fill the gap. So while the estimated 11m adults and 3m children in inadequate accommodation in England indicates a real need for more houses to be built, the market is far from ready to deliver them.
How will a change in borders impact the labour market?Shutterstock
Although, this influx of people might actually help to boost labour supply and allow construction to quicken – but only if building firms can hire them. Housebuilders’ sagging share prices in the wake of the referendum suggest they might not.
And although lower immigration from the EU would eventually ease demand for housing, it would also reduce access to those legendary Polish builders, who will be hard to replace with local labour.
Always hazardous, economic forecasting is especially uncertain in relation to housing because buyers’ and suppliers’ finances are in line for both positive and negative shocks, on an uncertain timescale. But as a sharp fall in prices will only occur if the economy turns downwards, it would not bring the boost to affordability that Generation Rent awaits.
Author: Alan Shipman, Lecturer in Economics, The Open University
At its meeting ending on 13 July 2016, the The Bank of England’s Monetary Policy Committee (MPC) voted by a majority of 8-1 to maintain Bank Rate at 0.5%, with one member voting for a cut in Bank Rate to 0.25%. The Committee voted unanimously to maintain the stock of purchased assets financed by the issuance of central bank reserves at £375 billion. The MPC sets monetary policy to meet the 2% inflation target and in a way that helps to sustain growth and employment.
Committee members made initial assessments of the impact of the vote to leave the European Union on demand, supply and the exchange rate. In the absence of a further worsening in the trade-off between supporting growth and returning inflation to target on a sustainable basis, most members of the Committee expect monetary policy to be loosened in August. The precise size and nature of any stimulatory measures will be determined during the August forecast and Inflation Report round.
Financial markets have reacted sharply to the United Kingdom’s vote to leave the European Union. Since the Committee’s previous meeting, the sterling effective exchange rate has fallen by 6%, and short-term and longer-term interest rates have declined. Reflecting the fall in the level of sterling, financial market measures of inflation expectations have risen moderately at short-term horizons, but only to around historical averages, and have fallen slightly at longer horizons. Markets have functioned well, and the improved resilience of the core of the UK financial system and the flexibility of the regulatory framework have allowed the impact of the referendum result to be dampened rather than amplified.
Official data on economic activity covering the period since the referendum are not yet available. However, there are preliminary signs that the result has affected sentiment among households and companies, with sharp falls in some measures of business and consumer confidence. Early indications from surveys and from contacts of the Bank’s Agents suggest that some businesses are beginning to delay investment projects and postpone recruitment decisions. Regarding the housing market, survey data point to a significant weakening in expected activity. Taken together, these indicators suggest economic activity is likely to weaken in the near term.
Twelve-month CPI inflation was 0.3% in May and remains well below the 2% inflation target. Measures of core inflation have been stable at a little over 1%. The shortfall in headline inflation is due predominantly to unusually large drags from energy and food prices, which are expected to attenuate over the next year. In addition, the sharp fall in the exchange rate will, in the short run, put upward pressure on inflation as the prices of internationally traded commodities increase in sterling terms, and as importers pass on increases in their costs to domestic prices.
Looking further forward, the MPC made clear in its May Inflation Report, and again in the minutes of its June meeting, that a vote to leave the European Union could have material implications for the outlook for output and inflation. The Committee judges that a range of influences on demand, supply and the exchange rate could lead to a significantly lower path for growth and a higher path for inflation than in the central projections set out in the May Report. The Committee will consider over the coming period how the outlook for the economy has changed in light of the referendum result and will publish its new forecast in its forthcoming Inflation Report on 4 August.
The MPC is committed to taking whatever action is needed to support growth and to return inflation to the target over an appropriate horizon. To that end, most members of the Committee expect monetary policy to be loosened in August. The Committee discussed various easing options and combinations thereof. The exact extent of any additional stimulus measures will be based on the Committee’s updated forecast, and their composition will take account of any interactions with the financial system.
Against that backdrop, at its meeting ending on 13 July, the majority of MPC members judged it appropriate to leave the stance of monetary policy unchanged at present. Gertjan Vlieghe preferred to reduce Bank Rate by 25 basis points at this meeting.
In major cities across the globe – from London to Manila, Auckland to Los Angeles – housing is becoming less and less affordable. This has caused a great deal of angst over house prices. But so far, politicians and the media have been much more effective at whipping up public anxiety, than putting in place actual solutions.
Over-inflated house prices are caused by more than just supply and demand. Policy changes often focus too narrowly on increasing housing supply, by opening up more land for development and speeding up the planning process. Of course, supply is important. If more people want to buy houses than there are houses available then prices may be forced upward.
But it is not enough to address only one cause. Another major driver of price increases is a housing market “bubble”. A bubble can be detected when property prices increase significantly faster than rents. In investment terms, this means you’re buying a more expensive asset, but it doesn’t give a higher return from rental income.
When prices are rising rapidly, buyers tend to anticipate that this will continue, guaranteeing a tidy profit when they eventually sell the property. Add record low interest rates and the resulting abundance of low-cost debt means that house prices can easily become over-inflated, relative to people’s incomes.
The 2013 Nobel Prize-winner Robert Shiller theorised this buyer behaviour and called it “irrational exuberance”. Housing markets in many cities across the globe are stubbornly following Shiller’s theory. As a bubble grows, more people are priced out of the market for buying property, while the apparent urgency to get onto the property ladder increases. Even if housing supply is increasing, the expectation of increasing property values will continue to drive this kind of behaviour in the market.
It is thought that London alone requires 42,000 new homes each year, based on population estimates. Between 2001 and 2011, Greater London’s population increased by 12.6%, while housing supply grew only 7.5%. It is only physically possible to meet this demand by putting more people into existing houses, leading to overcrowding, which is harmful to health and well-being.
So, building more houses won’t discourage irrational investment on its own. In fact, it might encourage more people to take on debt and invest in an over-valued housing market. If the bubble bursts – which would most likely be caused by a recession, or an increase in the cost of debt – prices will undergo a “correction”. Whether this correction is large or small, the financial impact on households and the threat to the stability of the national economy are significant.
How to rent a home
To diffuse this situation, we need to question our common assumptions about housing. The key role of housing is to meet the basic human need for safe and secure shelter. Housing policies mostly assume that home ownership is the only way to do this.
This idea has its roots in the post-war era, when governments promoted the idea of owning your own home, as the mark of financial security. Home ownership is not wrong – although households should seriously consider the risks of taking on large, long-term debts. But arguably, it isn’t an appropriate one-size-fits-all solution for cities in 2016.
Not ideal.from www.shutterstock.com
So, what other options do we have? For starters, better rental regulations could allow for long-term tenure and provide better protection for tenants. In Germany, only 39% of the population owns their own home, compared with roughly 60% in the UK.
But they also rent under very different conditions to people in the UK. Local governments can limit the rate of rent increases, and tenants have more rights to occupy a property over a long-term period. These arrangements make renting a viable option for people looking for long-term accommodation, which frees up household income to invest in other assets, with lower risk.
The real crisis
There are even more inventive ways to emphasise the importance of access to shelter, over and above home ownership. For one thing, there are some creative and forward-thinking design solutions on show at this year’s “Home Economics” display, at the Venice Biennale.
But we also need to rethink the way we plan our cities. In reality, the housing crisis stems from the fact that house building is left largely to the private market. Private developments don’t always include smaller, more modest homes for low-income households as well as expensive homes for the wealthy (the latter are usually more profitable). A survey of developments between 2014 and 2015 found that only 20% of the total number of homes built were deemed to be “affordable”.
Local governments require a certain share of new houses to cater to those on low incomes, but these affordable housing requirements are notoriously weak, too. In London, as little as 12% of dwellings in new developments need to be “affordable” – a classification which allows rents as high as 80% of market rate. In some cases, the price of a home deemed “affordable” was equal to 30 times the average UK wage.
Policies focused purely on expanding supply, without catering to different income groups, ignore the fact that cities depend on people who earn many different levels of income to provide key services. There are wider costs to society if cleaners, bar staff, creatives, cashiers and nursery assistants cannot afford to live in urban areas. Even if cheaper accommodation is available on the outskirts, this won’t offer a solution if commutes are long and costly.
We don’t know how or when the UK’s housing market bubble will burst, or how much prices might fall when it does. For the moment, those who don’t own property can take comfort in the fact that they aren’t taking on a mortgage in an overvalued property market. Meanwhile, leaders need to consider more innovative housing options, which focus on access rather than ownership. They need to provide meaningful alternatives for people on low incomes – or risk driving them out of our cities altogether.
Moody’s says that last Tuesday, the Bank of England’s (BoE) Financial Policy Committee (FPC) reduced the countercyclical capital buffer (CCyB) applied to banks’ UK risk-weighted assets to 0.0% from 0.5% as a result of expected softening in the UK economy following the UK referendum to exit the EU (Brexit). The reduced CCyB gives banks greater flexibility in providing credit to households and businesses, but reduces banks’ requirements to hold loss-absorbing capital, which is credit negative.
The 0.5% reduction of the regulatory capital buffers for UK banks in aggregate equates to £5.7 billion of capital. Given the BoE’s estimate of bank sector aggregate leverage of 4%, this allows for an increase in banks’ lending capacity of £150 billion. Such measures reduce the likelihood of a credit crunch and allow the UK’s financial system to absorb shock rather than amplify the negative effects on growth and investment from the uncertainty following the Brexit Referendum.
In 2015, net lending to the UK banking sector increased by around £60 billion, a small proportion of the additional lending capacity created by this reduction in capital requirements. Increasing the UK banks’ lending capacity will likely support their profitability, which we expect to be pressured by the low-rate environment, likely fall in demand for credit and an increase in credit impairments from the uncertainty around the UK’s vote to leave the EU.
Although the PRA and the FPC deem that the banks will still hold sufficient idiosyncratic and systemic risk capital to withstand a severe but plausible stress, these reductions in capital buffers will, if used to support lending, increase banks’ vulnerability to unexpected idiosyncratic and macroeconomic shocks. The effect will vary across UK banks, with leverage-constrained institutions less affected than those that are relatively more capital constrained. At 30 March 2016, the aggregate common equity Tier 1 ratio of the UK’s seven largest banks stood at 12.3%.
In March 2016, the FPC raised the CCyB to 0.5% effective March 2017 from 0.0%, with a 1% target for later in 2017, for the UK’s six largest banks1 in response to domestic credit risks, mainly related to an overheating housing market. Concurrently, to ensure there was no duplication in capital requirements, the FPC recommended reducing Prudential Regulation Authority (PRA) supervisory buffers (Pillar 2B) by 0.5%, offsetting the initial introduction of the CCyB. Despite this reversal in the decision to raise the CCyB, the BoE recommended to retain and bring forward the reduction in banks’ PRA buffer, to the extent the level of individual bank buffers is driven by macroeconomic versus idiosyncratic risk factors, thereby increasing available capital to support lending to businesses and households.
The CCyB is a macro prudential tool whereby the FPC adjusts bank capital requirements on a systemwide basis with the aim of dampening procyclicality of bank lending to the UK economy. This is intended to reduce the negative effects of boom and bust economic cycles, which are costly for banks and the wider
economy.
Although the CCyB may help avoid a credit crunch, amid a period of prolonged uncertainty around the UK’s future trade relationship with the EU, demand for credit is likely to be subdued, raising questions about the policy’s effectiveness on the real economy.
Immediately after the UK voted to leave the European Union, a number of lead economic indicators went into reverse. Notable among them were housing, property and real estate shares that fell sharply both in the housebuilding sector and among banks with large property lending exposure. This was seen as a simple response to economic uncertainty; fears emerged of falling house prices and slowing activity in the property market.
This week the big story has been the weakening position of major real estate funds, primarily investing in commercial property – office buildings, shops, warehouses. The firms which manage the funds, Standard Life for example, are concerned that if investors rush to withdraw their money, there will be insufficient capital to repay them. At first, a number of funds reduced the amount that investors could get back. Now, at least six of them – including Standard Life, Aviva and M&G – have suspended trading altogether. This has not happened since the global financial crisis.
While it reflects the basic illiquidity of commercial property compared to the short-term needs of worried investors – it clearly speaks to a much more profound concern about the economy and the exposure to housing and property.
Most of us are not heavily exposed to property funds, but many of us are homeowners or hope to be. The risk of falling house prices in the post-referendum environment may threaten highly leveraged mortgages where home owners have taken on lots of debt. The most immediate risk is of “negative equity”, when the value of the house is lower than the loan amount outstanding.
Normally, such “underwater” loans prevent people moving home, but in the absence of repayment difficulties they are not an immediate problem. You just have to wait it out until prices turn. However, the current situation is complicated and potentially more worrying.
This is because of the government’s £31 billion commitment to various Help-to-Buy schemes, £12 billion of which in effect guarantees the exposed part of mortgage loans should prices fall. A sustained price fall which becomes associated with increased defaults on mortgages could mean the government has to make good those guarantees after repossessions on affected properties.
Taking a pounding
Falling house prices in the short run will also reduce existing owners’ capacity to support potential first time buyers: the bank of mum and dad (or granny and grandad) stepping in to help. This will further reduce access to home ownership because younger households increasingly face unaffordable deposit demands before they can get a mortgage. At the moment, access to the levels of cash needed often depends on rather arbitrary good fortune, timing and location. It often boils down to whether your family have the means to lend or give you what’s needed.
Much has been made of the high level of speculation and overseas investment in London’s vertiginous housing market. There were already signs that the market was weakening cyclically prior to the referendum. Subsequently, however, we saw last week that some foreign banks were refusing to lend to their nationals for property investment in the UK. The depreciation of sterling may be encouraging such purchasers into the market, but only if they can find the means to borrow.
In this way we see that a UK housing market dominated by an open, world city in London, does become linked to currency movements and international capital flows, despite the fundamentally local nature of housing and real estate.
Falls in share prices, the forced intervention in real estate funds and worries about lending and government exposure to the downside of help-to-buy guarantees explain why the Bank of England says that the Brexit risks are crystalising and is moving to do something about it. However, it is hard not to draw the conclusion that the red flags going up across the housing and banking sectors reflect the underlying or chronic problems we know beset the housing market in Britain:
• Market imperfections in the form of the long term inability to build in sufficient numbers to address growing housing demand.
• Dwindling public investment in social and affordable housing in a period of high and rising housing need.
• Tax raids on the private rental market by targeting buy-to-let investors just when they are playing a critical role by filling the gap between the market and the non-market sectors.
• Tighter mortgage lending in the wake of the mortgage review that sought to reduce future lending risks after the global financial crisis.
• Privileged tax advantages to home owners which lock them in and create a society of insiders and outsiders. This worsens intergenerational inequalities and crowds out other forms of more productive business investment
Combining these points helps explain the underlying volatility in the housing market. It allows prices and market volumes to fluctuate more than the economy as a whole, while long-term real house price inflation encourages speculation in property assets and serves to frustrate people’s housing and labour mobility choices.
Governments and opposition parties must take concerted long-term action to normalise housing as an asset and a commodity. The policy world must recognise the need to approach housing more constructively, treating it as an entire system win which housing consumption rather than tenure matters most.
Frankly, we must seek to bring an end to a culture where politics is premised on defending existing asset owners’ housing capital rather than providing sufficient housing in the right places at prices and rents ordinary people can manage at different life-cycle stages. If not, we will be condemned to repeat these crises periodically, alongside slowly worsening chronic problems of exclusion, non-affordability and poisonous widening inequality.
Author: Kenneth Gibb, Professor of Housing Economics, University of Glasgow
Fitch Ratings says that there is little doubt that the UK referendum vote in favour of leaving the EU will take a significant toll on the economy.
Businesses are facing a surge in uncertainty on three separate fronts – the future of the UK’s trading relationship with the EU, the shape of the regulatory framework, and domestic political uncertainty, including the future status of Scotland. This uncertainty will prompt firms to delay investment and hiring decisions, while elevated financial market volatility will further damage business confidence.
We expect investment to fall by 5% in 2017 and by 2018 for it to be 15% lower than previously expected in Fitch’s May 2016 Global Economic Outlook (GEO). Consumption will not be immune to this shock and overall spending by UK residents will see a mild decline in 2017. The sharp fall in the value of sterling will provide some offset to the demand shock, with exports likely to benefit somewhat in the near term. Imports look likely to decline as investment contracts and foreign products become more expensive, resulting in expenditure switching to domestically produced goods and services and higher inflation. UK GDP growth is expected to fall to around 1% in both 2017 and 2018. This is a downward revision of 1 percentage point in each year from the May 2016 GEO.
The long-term impacts of Brexit on the economy are harder to estimate with great precision. However, in addition to less favourable access to the European Single Market, reductions in trade openness and inward FDI could harm productivity performance, while reduced immigration would slow labour supply and potential GDP. These negatives will likely outweigh any GDP gains from deregulation outside the EU or the redirection of EU budget transfers.
Brexit hits the world economy at a fragile juncture, with US growth recently weighed down by external shocks, but the direct near-term impact on the global economy is likely to be manageable. The trade exposures of US and Asian economies to the UK economy are small. The eurozone will suffer a larger shock from weaker UK demand and the depreciation of the pound, but for the block as a whole, growth adjustments will likely be significantly smaller than for the UK. Global financial market contagion beyond the UK has not been particularly severe since the vote, although European bank shares have fallen sharply as concerns about profitability have risen. Liquidity provision and monetary policy adjustments by global central banks should be able to contain the risk of a significant and widespread tightening in global credit conditions, although a further strengthening of the dollar – with implications for emerging market currencies and debt service – cannot be ruled out. Further Fed tightening is now likely to be delayed until December 2016 and the ECB is expected to persist with asset purchases beyond March 2017. The Bank of England is likely to lower interest rates to 25 bps later this year.
Nevertheless, medium to long-term risks to the global economy from the Brexit vote would rise in the event of increased political fragmentation pressures in the rest of the EU or a reversal of globalisation that culminated in rising trade protectionism.
Rating agency Standard & Poor’s (S&P), the only agency which had previously given the UK a AAA rating, just revised it down. S&P said the the referendum result could lead to “a deterioration of the UK’s economic performance, including its large financial services sector”. They say Brexit will “weaken the predictability, stability, and effectiveness of policy making in the UK”. This follows downgrades from Fitch – from AA+ to AA – forecasting an “abrupt slowdown” in growth in the short-term and Moody’s last Friday cut the UK’s credit rating outlook to negative.
A ratings drop is likely to raise the cost of Government debt on the international markets. Here is the pound US$ chart, which fell further on Monday to a 31 year low.
British people have woken up to the news that their country has voted to leave the European Union. Along with this, there has been turmoil in financial markets – the pound has hit a 30-year low and the FTSE dropped more than 8%.
Though the Brexit process will probably take two years (and the UK will remain a full member of the EU in the meantime), some aspects of the decision will affect British people straight away.
1. The pound in your pocket
There is inevitably going to be a period of uncertainty and turmoil. As the referendum result emerged, the pound fell 10% against the US dollar on the foreign exchange markets and 7% against the Euro. If this persists, things the UK imports, such as oil (affecting domestic fuel prices and petrol), foreign cars, coffee, bananas and clothing, will cost more. Overall, then, the general price level may rise meaning that your income will not stretch quite so far.
If you’re holidaying abroad over the coming months and haven’t bought your currency yet, the weaker pound means you’ll also now pay more.
2. Your job and income
A weak pound affects industry as well and so may impact on jobs. Company costs will rise if they import their raw materials and most firms will be hit by higher fuel prices. But the fall in sterling makes it easier for exporters to sell their goods and services abroad. So some jobs and wages may be more at risk, while recruitment rises in other areas.
Longer term, economists have been remarkably consistent in predicting that UK growth is likely to be lower outside the EU than it would have been inside. Businesses do not like uncertainty, so they may put off investing in new plant, machinery and jobs, as being outside the EU trading bloc may make trading with other countries more difficult and some firms may decide to quit the UK. This could mean that jobs and wages will be lower than they might otherwise have been, though not necessarily lower than today.
Before the referendum, Chancellor George Osborne threatened a post-Brexit emergency Budget that would cut public spending and raise taxes. This seems an unlikely immediate response since it would further depress the UK economy just when it is reeling with uncertainty and MPs across all parties were quick to say they would not support such measures. A new prime minister, due from October, may well appoint a new chancellor with his or her own ideas.
3. Your savings and pensions
Uncertainty while markets adjust and firms decide how to respond means the UK stock market is likely to be volatile for some time. Anyone who has recently retired and opted to take an income using drawdown (periodic cashing in of a pension fund still invested in the stock market) may have to take tough decisions about drawing less income now or risk running out of retirement savings later on.
Pensioners may face some complications.shutterstock.com
Savers have suffered since the global financial crisis of 2008 with rock-bottom interest rates. It’s unclear what might happen to these. On the one hand, rising consumer prices may push interest rates up; and credit rating agencies have said they may downgrade UK government debt which means the government would have to raise interest rates to persuade savers to buy its debt. But, if the economy struggles to grow, the Bank of England – which has said it stands ready to deploy any measures to maintain financial stability – might embark on new rounds of quantitative easing to keep interest rates low to encourage economic growth.
4. Your home and mortgage
While savers would welcome a rise in interest rates, this would increase mortgage repayments for borrowers and could even trigger repossessions. The International Money Fund has predicted that UK house prices could drop sharply post-Brexit. You might be concerned about that if you are in one of the six out of ten UK households that own their own home. But this could be good news for younger generations who have been struggling to afford a home.
Author: Jonquil Lowe, Lecturer in Personal Finance, The Open University
With the UK vote count complete, 48.1% are for remaining a member of the European Union and 51.9% to leave. A number of factors explain why remain slipped from being a reasonable cert by a (small) majority to defeat. The larger than expected turn-outs at 72.2%, in northern England, and among lower socioeconomic groups tipped the balance towards an exit. Remain under performed in areas where they were expected to be strong, but were still ahead in the London area and Scotland. The financial markets continue to exhibit significant volatility as traders reset their their expectations, some would say they are panicking! It looks like a wild ride will continue for some time.
Here is the Pound US Dollar Chart for the last few hours. Down 9.3%!
