After sharp volatility at the start of the summer, principally surrounding the Brexit debate in the UK, global markets are approaching the end of the holiday period much calmer with the Vix volatility index back at its year lows after peaking at 26 in June.
Much of the reason for this decline is the fact that Brexit did not in the end turn into the storm that was expected, with only sterling experiencing any lasting impact and with other global markets largely unaffected. In fact, global borrowing costs have continued to decline and equity markets have been strong through the summer.
Despite apocalyptic warnings before the referendum, markets have been relatively reassured that Brexit may not in fact lead to the economic dislocation that was feared, with UK economic data largely holding up in the aftermath of the vote and political continuity being promised by the appointment of the new government led by Theresa May.
Although sentiment indicators in the UK showed an immediate negative reaction to the surprise referendum outcome, with the UK’s manufacturing PMI plunging into contraction territory, the other “harder” data available since then has been relatively comforting, showing retail sales rising strongly last month, prices firming, applicants for unemployment benefit declining and the housing market steady.
Farther afield there was next to no contagion in other neighbouring economies either, with the Euro area PMI rising slightly last month and firming further this month, despite the euro’s currency appreciation against sterling.
Japanese yen strength is seemingly not harming the Japanese economy much either, with its manufacturing PMI improving for the third straight month in August.
The US economy has also remained resilient, with jobs being added and other activity indicators firm, so much so that the Federal Reserve was sufficiently reassured to downgrade the risk posed to the US economy.
Although the IMF downgraded its forecast for global growth in the wake of the UK Brexit decision, markets were surprised that its forecasts were not much worse given the warnings it made in the run-up to the referendum. In fact, the IMF said that if it had not been for Brexit it would have actually raised its global growth outlook for the first time in years.
In the event global growth forecasts this year and next were lowered by just 0.1 percentage points to 3.1 per cent and 3.4 per cent respectively, while its UK growth forecast was cut to 1.7 per cent and 1.3 per cent in the same period, nothing as bad as the IMF had previously implied and still better than many other leading economies in the world, including the euro zone.
The fact that the new UK government seems in no hurry to trigger article 50 of the EU constitution to initiate exit talks also promises a more drawn-out period of negotiations than many had expected, effectively kicking the reality of Brexit out as far as 2019.
Mixed voices from EU countries about what kind of Brexit they will insist on are also providing some optimism that the UK may still manage to avoid draconian consequences. With the Bank of England having already moved preemptively to cut interest rates to 0.25 per cent, and with sterling having fallen by nearly 15 per cent, the markets might even start to imagine that the near-term prospects for the UK economy could actually be quite favourable.
Export order books were at a two-year high this month according to the Confederation of British Industry, with total order books “comfortably above” the long-run average.
However, it is important not to get carried away by the relative calm that has prevailed over the past month or so. As it was probably right not to overreact to the sharp drop in confidence levels last month, or indeed to the cataclysmic warnings before the referendum, so the improvement in the “hard” data since the vote may also exaggerate the resilience of growth going forward.
It is still likely that UK growth will take a short term hit and it will take time for the full impact of Brexit to manifest itself, on the UK economy as well as on its global trade partners and regional neighbours. Policymakers should remain vigilant to these risks even as the immediate clouds related to the issue might appear to have lifted.
Tim Fox is chief economist and head of research at Emirates NBD.
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