How Brexit will impact the pounds in people’s pockets

It was Donald Rumsfeld, then US Secretary of State for Defence, who most famously explained difference between ‘known knowns’, ‘known unknowns’ and ‘unknown unknowns’.

He was responding to a tricky press question in 2002 about weapons of mass destruction in Iraq, but the framework can as usefully be applied to the effect of the referendum vote on the British economy.

The problem for us, as it was for him, is that the number of items in the ‘known knowns’ category is too small. In terms of the economic effect, four months after the vote, the ‘known known’ items are only (a) everyone was shocked in July and (b) the currency has fallen.

Teetering on the edge of that category are that forecasts for macroeconomic growth for 2016 and 2017 have been scaled back, and the idea that the Bank of England might one day actually raise interest rates is ever more remote. But these latter two effects are around forecasts of future events so aren’t really yet ‘known’.

The ‘known unknowns’ bucket, in contrast, is disturbingly full, and includes specific questions about the working permits of individuals, through sector-wide questions around trading relationships to economy-wide questions around confidence and what that means for overall economic growth.

Last week, however, we saw the potential for unknown unknowns to rear their head in the form of the Unilever dispute with Tescos. If, pre-Brexit, the European Commission had threatened to take away our Marmite, the anti-European press would have had a field day.

The worst-case scenario is a combination of severe restrictions on trade that mean businesses feel their prospects are weaker, combined with a perceived lack of leadership and the general sense of uncertainty that arises from unanticipated negative events.

The best-case scenario is a negotiated agreement that is true to the spirit of the referendum result without jeopardising things we take for granted, combined with a sense that the government is in control and understands what it is doing.

The problem is that, in the absence of the best-case scenario, we fear the worst-case. But actually, all we have seen so far in terms of real outcomes has been the fall in the currency. And so all we actually know is that we’ll get less euro for our money when we go abroad.

The currency fall has also pushed up the cost of petrol a little in recent weeks, because oil is priced in dollars and a pound now buys less of them. But this should not be overstated because in general changes in tax and the international price of oil itself have a greater effect on the petrol price.

Mortgage holders fearing interest rate rises will be relieved that the prospect for this has receded: now is a very good time to remortgage.

Beyond that, there is little certainty. While the textbooks say that a depreciation will make exports cheaper and imports more expensive, this only really applies to simple traded goods made with local components.

So while the increase in the price of (largely imported) clothing and footwear in Tuesday’s inflation figures might be partly due to the fall in sterling, and the price of food imports (and/or Unilever goods) might follow in time, don’t expect our exports of complex financial services, or sales of anything with an international supply chain or a large fuel bill, to receive a corresponding price-related boost.

And remember inflation is still undershooting our target, petrol prices are still lower than they were a few years ago and in any case prices might be expected to start rising a little when unemployment is as low as it currently is.

The main point is to remember why the pound is falling in the first place. It’s because the items in the ‘known unknowns’ basket are so large.

The value of sterling is an immediate international crowd-sourced judgement of Britain’s economic prospects, and they got worse when the Prime Minister’s conference speech increased expectations of a ‘hard’ Brexit.

If in fact the best-case scenario comes to pass, the pound may well reverse its recent losses. So the slide in sterling doesn’t flow from Brexit itself, it flows from the worries people have about what it might mean.

The solution? If you need to borrow money, now’s a good time.

If you need to take sterling abroad, commiserations.

If you’re hiring a senior expat and paying them in pounds, you’ll have to offer them more.

If your business is exposed to currency risk, it just got riskier.

If you’re tempted to use Brexit as an excuse for putting up prices, be wary of #Marmitegate.

But most importantly, don’t forget that this is the phoney war. If it shows anything it is that the priority for government is to provide a routemap to greater certainty through a policy response that engenders confidence.

Donald Rumsfeld might have got himself out of a tricky question on Iraq by an explanation of the various categories of knowledge and ignorance, but right now Britain needs more actual facts it can rely upon.

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