Uncertainty will hang over the UK until we have a decision on the EU referendum. Thereafter, we are told that Brexit will not only ensure uncertainty continues, but increases.
I would recommend not falling into the trap of exaggerating the actual “harm” uncertainly does to our economy. After all, it performed remarkably well considering the uncertainty over the outcome of the 2015 general election. It also performed perfectly well when there was the question of Scotland’s potential break from the union.
Some will no doubt claim we will never know how good the economy might have been were it to have been free of election and referendum uncertainties. To which my reply is that we are surrounded by uncertainties and continue by and large to behave calmly.
Others will claim even the mere possibility of Brexit involves a wholly different set of uncertainties. And I will counter that if the UK’s labour market were to soften it would do so from an impressive level of strength. Furthermore, if capital markets do continue to sell-down sterling, this will hardly prove unwelcome to those across the economy who will be able to exploit a more competitive and affordable pound.
If we turn to the gilt market and consider yield performance over recent years of “uncertainty”, we see little discernible difference in how US treasuries performed through the same periods. As for “underperforming” comparable German Bunds, one should note the European Central Bank’s rate cut as the explanation, not increased risk-aversion towards UK government debt.
I am not suggesting that uncertainty ahead of the referendum fails to influence economic activity within the UK. What I am asking is that ahead of the referendum we keep our heads when it seems that all about us there are those losing theirs.
Each dip in sterling may well have inflation implications. But at a time when the greatest fear is being mired in deflation, this is hardly a bad thing. A weaker pound also raises the intriguing prospect of UK assets becoming more affordable for overseas investors who believe that the probability of Brexit is being exaggerated and/or its unfavourable economic consequences for the UK economy overstated.
Those with this mindset could only welcome any downwards repricing of UK real estate and sterling assets more widely, since this would provide them with an ever more affordable acquisition.
I am reminded at this point of a fateful exit in 1992. Back then, when the markets closed on 16 September we expected to wake to a base rate of 15%. As it was, in the early evening Norman Lamont stood in front of the Treasury to announce the pound’s membership of the European Exchange Rate Mechanism had been suspended, and so too the rate hikes he had earlier announced in the government’s efforts to forestall just such an exit (tens of billions of pounds of our foreign reserves were also squandered to that purpose).
What makes this eventful day so very memorable is that having at first been branded “Black Wednesday”, it instead quickly came to be remembered as “White”. This was because on 16 September the UK escaped from the constraints imposed on it by the ERM (for the record, on 17 September the FTSE 100 rose by 4.4% – among its best-ever percentage rises). It is true that almost all ERM pegs were reset, but only the pound escaped entirely from the mechanism which would go on to forge the euro (how Greece and others in need of currency freedom now wish they had escaped with the UK).
The UK’s ERM exit meant a more competitive pound as well as a progressive and much-needed cut to the base rate. Membership of the ERM had meant the UK had lost self-determination, and this was reclaimed by exiting. Within a handful of years the “flexible” pound would buy more than the 2.95 Deutschmarks which the ERM had dictated should be its central rate.
There are, in my mind, three clear lessons from September 1992. One is that in a period of uncertainty markets naturally factor in the perceived worst outcome. However, if/when this worst-case outcome is not realised, the affected asset prices rebound in an impressive relief rally, resulting in a “hockey-stick” move.
Another lesson is that flexibility to act is a sovereign economy’s most powerful weapon.
And the third lesson is that clearly signed exits exist in enclosed spaces for a very good reason: they help you escape trouble.
Savvas Savouri is chief economist at Toscafund
