Oddly enough, the UK had in fact pulled a similar move in 1992 by removing itself from the European Exchange Rate mechanism (ERM). This drop has 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, a crashing pound and an increase of the UK’s economic separation from the rest of Europe. The comparison, however, ignores what makes the exit this time radically different according to Capital Economics and explains the stock drop.
In 1992, the ERM was leaving the pound uncompetitive and “strangling” the UK’s economy, according to Capital Economics. Thus, the exit may have left the pound weaker for a time, but it was seen as an overall positive for the growth of the economy.
This time around 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.”
So instead of being seen as a liberation from Europe, many investors are worried that the uncertainty of trade deals and ability of the UK to access the EU market is going to be a drag on its economy. Thus, the stock market reacted negatively.
There is hope, however, that this could be a short-run worry on the way to a economic move similar to 1992.
“Admittedly, the outlook for the earnings of UK companies ought to improve eventually as a result of the favourable impact of sterling’s depreciation on activity,” said Capital Economics’ note.
“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.
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