21 Jun 2016
Investors anticipate hit to economy
The only certainty about a ‘Brexit’ is uncertainty, according to a London Business School economist.
Writing in Forbes, Linda Yueh, Adjunct Professor of Economics, London Business School, argues that investors are putting their money on one particular outcome of Thursday’s referendum, regardless of a Leave or Remain vote.
“Investors appear to be putting their money on one outcome – a hit to the economy regardless of the referendum result.
“This is being reflected in gilt yields – the interest rate that the UK pays on its government bonds,” says Linda Yueh. “Yields on 10 year debt have fallen to record lows – the government now pays 1.125% to borrow for a decade. Record lows were also reached for 20 and 30 year debt.
“For the first time, it costs less than 2% for the British government to borrow for 30 years.”
Yueh also points to bond yields which reflect where markets expect interest rates to be, affected by the Bank of England base rate and the state of the economy.
“If the economy is contracting or weak, the Bank of England would be expected to cut rates,” continues Yueh. “It’s also influenced by the world economy that affects Britain, which doesn’t look too rosy as globally bond yields have also dropped. Thus, investors point to two main reasons for their global trades: Brexit and the Fed.
“A lower interest rate in the future signals that investors are concerned about a weaker economy. But, they’re not concerned about the ability of the British governments to pay its debt, which would send yields higher.
“Confidence in the government alone of course doesn't move yields on longer-term debt as much as interest rates, economic growth, and inflation.”
If Britain votes to leave on June 23rd, there will be at least two years of uncertainty while a new deal with the EU is negotiated, says Yueh.
“Uncertainty tends to dampen economic activity. But, if the Bank of England is right, they expect some continuing uncertainty which is likely to dampen economic activity for a while longer, even if we stay in the EU as the economy re-adjusts.
“Investors may or may not be getting it right, but uncertainty tends to make people cautious. And for the economy, that tends to mean being conservative about where it’s headed.”