- Stefan Wermuth/Reuters
Oddly enough, the UK actually pulled a similar move in 1992 by removing itself from the European Exchange Rate Mechanism. The two events have drawn comparisons from investors such as George Soros (who helped bring about the 1992 move) and market analysts.
While the precipitous drop in the pound is no doubt an apt comparison, there is just one problem with the Brexit-is-like-1992 ideas: stocks.
Here’s a breakdown from Capital Economics on the dichotomy (emphasis added):
“In the first four days after the UK exited the ERM on 15th September, sterling fell by 6% against the German mark. This was accompanied by an 8% rise in the multinational-dominated FTSE 100. The equity index also climbed in the ensuing months, as the UK’s currency continued to fall. And in doing so, it substantially outperformed Germany’s stock market. In the first four days after the UK voted to leave the EU, sterling fell by an even-larger 8% against the euro. This time, though, the FTSE 100 fell by 6%. And it barely outperformed Germany’s stock market.“
There are a lot of similarities here, with a crashing pound and an increased separation between the UK and the rest of Europe. The comparison, however, ignores what makes the exit this time radically different, Capital Economics said, and explains the stock drop.
In 1992, Capital Economics said, the ERM was leaving the pound uncompetitive and “strangling” the UK’s economy. Thus, the exit may have left the pound weaker for a time but was seen as an overall positive for the growth of the economy.
This time, however, it’s different. Here’s Capital Economics again (emphasis again added):
“Prior to last week’s referendum, by contrast, the UK was not bound by a growth-retarding exchange rate. What’s more, the country’s formal trading relations with other EU members will now need to be renegotiated against the backdrop of growing political divisions at home. The uncertainty that is set to prevail until the UK’s new relationship with the EU becomes clear means that the UK economy is likely to suffer in the short run, even if talk of a deep recession seems overdone.“
Many investors are worried that, rather than be seen as a liberation from Europe, the Brexit will be a drag on the UK economy. Those worries, specifically focused on uncertainty around trade deals and the ability of the UK to access the EU market, were followed by a negative reaction in the stock market.
There is hope, however, that this could be a short-run worry similar to that of 1992.
“Admittedly, the outlook for the earnings of UK companies ought to improve eventually as a result of the favorable impact of sterling’s depreciation on activity,” Capital Economics’ note said.
“As it happens, our view is the UK economy will cope reasonably well in the long run outside the EU. But it may take time before the UK stock market feels the benefit.”
Right now it appears that the 1992 playbook isn’t going to work, but the weaker pound will allow the UK to export its goods easier and could have other positive economic effects. So it may not be time to throw out the playbook yet.