We are now beginning stage two of the Brexit fallout. We have witnessed the immediate shock and the accompanying carnage on world sharemarkets. Now we will witness interest rates around the world start to fall as central banks attempt to cut off any prospect of recession at the pass.
Australia will be no exception.
The chance of the Reserve Bank deciding to drop interest rates by 25 basis points in the next month – or even the next week – are better than they were before a mob of Britons made the mistake of deciding to go it alone in an economic sense.
And the volatility in sharemarkets remains. After see-sawing over the past four days, the Australian sharemarket opened up almost 1 per cent. However Australian companies with a direct exposure to the UK and Europe have seen almost no reprieve. Their share prices were hammered on Friday and have not really recovered.
The UK, European and US equity markets have rebounded to recover some of the losses sustained since last Friday. But no one is prepared to say markets won't go down again. Investors are fractious, sensitive and reactive to any fresh triggers.
Before the Brexit shock, a reasonable number of economists were betting the Reserve Bank would cut interest rates in August after it had received fresh quarterly consumer price index numbers that provided it with an update on inflation. The conventional wisdom was that a weak set of inflation numbers in the June quarter would trigger another rate cut.
But the world economy changed last week. Many would consider that the RBA would see a rate cut next Tuesday as premature given that the real fallout of the Brexit vote remains uncertain. But some believe a pre-emptive move by the RBA is not out of the question.
If the RBA decides to wait, then August is a really good bet.
The UK could well fall into recession. Its currency has collapsed and the jury is still out on whether other European countries will attempt to follow Britain and leave the EU.
All this leads to enormous uncertainty in various economies and we will see a rush towards monetary easing as an insurance policy against recession or, in Australia's case, against stalling growth.
Reducing interest rates – which would mean taking rates further into negative territory in Europe and Japan – is a mechanism to protect currencies from rising.
The RBA will be paying most attention to what is going on in the US. In the before-Brexit world, the US was on the cusp of increasing interest rates, with two rises expected this year.
Now that has been turned on its head. There is now the expectation that the US could move to cut rates by the end of the year. Such an outcome would push the US dollar down and, by default, push the Australian dollar up.
The Reserve Bank has long been attempting to put downward pressure on the Australian dollar which it sees as too high. It has always been mindful of the global pressures that affect both Australian consumer and business sentiment. Even before Brexit these groups had been responding negatively to the upcoming election. Numerous businesses had sighted pre-election uncertainty as the reason consumers were reluctant to spend.
The biggest recent boost to consumer confidence was seen when the RBA cut interest rates in May. Australian sentiment is particularly leveraged to interest rates given the proportion of the community with mortgages.
Given Brexit was an event uncharted by history, it is a fair assumption that even when the RBA meets in early August it will still not have great visibility around how the event will play out – even over the next year.
While disentangling the UK from Europe will be painful for those involved, there are plenty of experts hopeful that the ripple effects won't hit Australia given our direct trading ties with the UK are not significant.
But as we are part of a global economy we cannot completely avoid the flow-on effect to our sharemarket and currency.
