Opinion: In the wake of the Brexit vote, will the economy now collapse?

Ahead of the referendum, those campaigning for the UK to remain in the EU warned of the economic catastrophe that would ensue if the UK voted to leave, including a recession, a rise in unemployment, a spike in mortgage rates and fall in house prices, as well as a collapse in the exchange rate.

While the UK economy clearly now faces some big challenges, I think that the ultimate impact on the economy over the next few years will be less severe than some of the more pessimistic estimates.

“For the next two years (at least), all of the existing agreements including free trade and the free movement of people remain in place”

Paul Hollingsworth, Capital Economics

The first thing to say is that we have not yet left the EU and there is even speculation that we may not actually leave. For the next two years (at least), all of the existing agreements including free trade and the free movement of people remain in place. And it is certainly possible that the next prime minister (whoever he or she is) will lead us towards an EEA-style agreement (often referred to as the “Norway option” or “Brexit lite”) that would closely mimic our current arrangement and therefore reduce uncertainty.

Moreover, HM Treasury’s pessimistic analysis about the short-run impact of a Brexit assumed that policymakers did not act to support the economy. But it seems highly likely that the Bank of England will cut interest rates in the next couple of months. And Chancellor Osborne appears to have cancelled his post-Brexit “austerity Budget”. Indeed, the fiscal squeeze will probably be put on hold for a few more years.

Investment casualties

The main casualty of Brexit in the short run will be business investment. After all, it will be businesses that are most affected by uncertainty surrounding the UK’s new relationship – what it means for tariff rates, movement of workers and regulation to name but a few issues. But business investment only accounts for 10% of the economy and within that roughly 10% is related to exporting to the EU. Indeed, many businesses will invest regardless of the UK’s future relationship with the EU.

Of course, the outlook for consumer spending is still weaker now than if we had voted to remain. There are a number of channels through which Brexit could dampen consumer spending. There are three in particular worth mentioning:

1. The impact on consumer confidence
2. Lower real disposable income
3. Wealth effects from movements in asset prices.

Consumer confidence will almost certainly weaken a bit, along with the economy. That said, political uncertainty hasn’t tended to dent sentiment too much in the past.

Meanwhile, the lower pound will drive inflation up over the next couple of years and wage growth will probably slow, meaning that real income growth will take a hit. Finally, while talk of a house price crash seems overdone and equity prices have already recovered, so the impact on consumers’ wealth may not be too large.

The upshot is that the economy is set for a soft patch over the next few years. But talk of an economic collapse is surely overdone.

• Paul Hollingsworth, UK economist, Capital Economics