A closer economic analysis of Brexit foreshadows opportunities for Australian business
Economic Analysis Branch and Europe Trade and Brexit Unit
Amid an already subdued global economic outlook, the Brexit decision created political and economic uncertainty and wrong footed markets, triggering a ‘flight to safety’ by global investors. Money rotated out of riskier assets, including equities and most currencies, and into safer assets including bonds, US Dollars, and Japanese Yen.
Markets subsequently stabilised on the expectation of accommodative government and central bank policy responses. Most markets returned to pre-Brexit levels, although the British Pound and European bank stocks remain well below their pre‑referendum levels.
Australian financial markets, like others around the world, responded to the initial Brexit-induced volatility but soon stabilised. Australia has a well-deserved reputation for resilience during periods of financial volatility. Greater orientation to Asia’s dynamic growth markets, limited direct exposure of Australian banks to the UK and Europe, and an ability to adapt to changing global economic circumstances also contributed to limited exposure and fallout. Australia continues to be well positioned to build on our track record of economic growth.
Near-term economic outlook
The IMF recognised the negative impact of Brexit uncertainty on investment and trade, trimming otherwise stable global growth forecasts in its July update to the World Economic Outlook . The IMF’s October forecasts left these forecasts largely unchanged. The IMF assumes Brexit‑related economic fallout will be substantially confined to Europe, with the underpinning assumption that impending UK‑EU negotiations will preserve historical gains from trade.
The IMF forecasts the UK economy will slow between 2016 and 2017 as the effects of uncertainty come to weigh on business and consumer spending decisions. Early indicators out of the UK confirm initial hits to business and consumer confidence.
- The July Purchasing Managers’ Index surveys showed steep falls in UK business expectations, activity, and new orders.
- GBP depreciation has since provided some encouragement to UK export manufacturers. Consequently, the composite index, which also includes services, stabilised in September, after having reached its lowest level since 2009 in July.
- UK services businesses are uncertain about what Brexit means for them. While the October 2016 British Chambers of Commerce Quarterly Economic Survey suggests sales are stronger for manufacturers than services businesses, investment intentions are slowing for both.
- Construction sector expectations, after pointing to the largest slowdown since the Global Financial Crisis, rebounded to pre-Brexit levels in September 2016. This rebound was led by residential construction, with commercial building work still declining, as new business investment is deferred in the face of uncertainty.
- In the aftermath of the referendum outcome, the long‑running GfK survey of consumer confidence dipped sharply (its largest monthly fall since 1990). British consumers now appear to have largely shrugged off Brexit fears about the economy thanks to an easing in credit conditions, near-term support for economic activity from the lower pound, and as lower interest rates encourage people to spend rather than save.
Responding to challenging near-term economic conditions, the Bank of England swiftly loosened UK financial conditions, cutting interest rates, increasing asset market purchases and easing bank cyclical capital buffers to encourage more lending to businesses and consumers. Subsequent retail and household credit data suggests this improved the outlook for consumers.
Other signs of the impact of uncertainty in the aftermath of Brexit are evident in the international education market. An August 2016 Hobson’s survey suggested a third of prospective international students are now less likely to study in the UK. Notably, the same survey showed a 20 per cent net increase in prospective students listing Australia as a more likely study destination.
Longer-term economic implications
The October 2016 IMF World Economic Outlook stresses that Brexit is still an unfolding event. The impact on mutual trade and financial flows will not be clear for several years. Looking ahead, the IMF expects Europe to bear the brunt of negative economic impacts over the next two years. Due to weak investor confidence and uncertainty in the wake of the Brexit vote, growth for the Euro area as a whole is projected to decline slightly to 1.7 percent in 2016 and 1.5 percent in 2017. Reductions in growth forecasts are largest for the UK (down 0.1 per cent in 2016 and 1.1 per cent in 2017).
Should uncertainty linger, historic gains from trade be reversed, or Brexit provoke political instability in Europe, then downside effects could worsen. Negotiations between the UK and EU will largely drive changes in these risks.
London’s ongoing status as a global financial centre, the continued efficiency and stability of the global banking system, and future EU political cohesion will be among key determinants of long-term economic outcomes.
Australia has consistently proven resilient to financial instability and economic shocks and remains well-placed to deal with the economic and financial market response to Brexit.
While the UK remains important, the overwhelming majority of Australia’s merchandise trade is with Asia and we expect continued economic growth in the region to provide support for Australia’s key exports, including commodities.
Emerging export growth areas, including medical technologies, niche manufacturing, agricultural goods and advanced materials may even benefit over the longer-term as the UK and EU negotiate new arrangements that support their complex array of existing intra-EU business relationships.
The UK and other EU countries remain key investment partners. The Australian Government intends to pursue new trade and investment opportunities with both the EU and UK, including advancing progress towards a free trade agreement with the EU and striking a bilateral FTA with the UK as soon as circumstances allow.
Investors from the UK and EU have around $1 trillion invested in Australian assets.
- More than half of this is from UK investors, reflecting long standing legal and cultural bonds. The UK is our second largest investor country behind the United States.
- Other EU countries now have almost half a trillion dollars invested in Australia, reflecting Australia’s diversification of capital sources and European financial structuring arrangements.
- Most of this investment in Australia comprises of portfolio investment in debt and equity securities; around 15 per cent is held as direct business investments.
Investment held by Australian investors in the UK and EU is also worth nearly $600 billion and is more skewed to equity relative to assets held by UK and EU investors here. UK and EU investors have a collective net investment position of over $400 billion in Australia. The EU and the UK will remain key sources of investment into Australia.
Australian business can capitalise on the relatively greater certainty global investors face investing in Australia. Our resilient economy, strong and stable institutions, higher yields and favourable currency-adjusted pricing continue to attract global investor interest. Diversified sources of capital helps Australia maintain its reputation for resilience and adaptability to global economic change.
The 10 to 15 per cent post-Brexit depreciation of the GBP against all major currencies (as at 10 October) makes some opportunistic investment in the UK more attractively priced. As the Reserve Bank of Australia noted when it lowered the cash rate on 2 August, AUD depreciation since 2013 has helped our traded sector, though an appreciating exchange rate could complicate the necessary economic adjustments underway. Australia remains an attractive destination for investors and Australian exports are expected to continue contributing to domestic economic growth.
The Australian financial services industry is poised to benefit from any global banking and financial services restructuring, along with related technology investment trends. Niche areas such as Fintech, Islamic finance and Cyber Security continue to attract investor interest. Uncertainty abroad could enable Australia to increase its share of global technology investment portfolios.