What is the outlook in the wake of the UK's decision to vote for Brexit? I have taken a positive view of the economic implications of Brexit, but in doing so argued that the likely impact would be like a tick, or 'Nike swoosh'. That is, there would be an initial period of uncertainty. And in many respects that is what we are seeing in terms of the financial market reaction, with sterling and equities falling significantly.
Such a market reaction is not a surprise given the referendum outcome. It reflects concern about the economic implications, and in particular uncertainty or concern about what lies ahead. The resignation announcement by the Prime Minister will add to this. There is now a three month period during which a new PM needs to be elected. It is not clear whether there may be other political casualties in coming weeks.
The economic and financial market impact depends upon the interaction between the economic fundamentals, policy and confidence.
Of these, and vitally important for the markets in the near-term will be the policy response. The Bank of England Governor's comments on Friday morning were very reassuring. He was quite right to highlight that the UK financial system is now far more resilient than it was after the 2008 financial crisis, being well capitalised, liquid and strong. This is a testimony to the success of the policy framework that has been put in place in recent years. The aim will be to prevent a self-feeding downward spiral in the markets, and to stabilise the banks in order to prevent a credit crunch.
Moreover, the Bank of England has made clear it will provide sufficient liquidity. Policy rates will stay low, and could fall further. In a low inflation environment, a weaker pound should be a welcome boost. Although the inflation fear from a weaker pound should not be overstated, this is likely to be one of the areas of economic debate in coming weeks. The extent of the pound's fall may prompt some, including perhaps one or two members on the Monetary Policy Committee to voice concern about inflation. Despite this, inflation will stay low and rates should fall.
The Bank of England's actions are likely to be reinforced by those of a number of other central banks. Given the extent to which financial markets across the globe have focussed on Brexit, we should expect there to be additional liquidity provided by the ECB, and possibly others. Gilts, and other bonds, will benefit from a flight to quality.
The UK's economic fundamentals are mixed. Although growth has been steady and employment solid, the economy still suffers from twin deficits: the budget and current account. Indeed, concerns about the latter also contributed to the sharp fall in the pound, as did the realisation that the authorities were not going to intervene to defend it. Ahead of the Referendum the Chancellor voiced the idea of a snap Budget. That seems unlikely, and indeed if there was one it would not be the austerity budget he talked of, and instead would need to aim at boosting demand. For now, it is more likely that fiscal policy will remain unchanged, and the shock absorber for the economy will be the Bank of England as rates stay low, and possibly fall further.