Two major ways a Brexit could affect the Australian economy

People living in Britain may have been dealing with the potential ramifications of a British exit from the European Union for a while now, but the question remains – what could this world-changing event do to the Australian economy?

The answer? Actually, quite a lot.

Examining the consequences of a “Brexit” is especially prudent for Australians. Recent polling found fears over economic uncertainty in the Eurozone has had a negative effect on stock markets around the world, and those in favour of an EU split have a lead in British polls.

But a dip in the Australian Securities Exchange is actually just the beginning of what could be a drain of liquidity from Australian markets caused by a British exit from the EU.

There are two major ways to look at what a “Brexit” could mean for the Australian economy. The first concerns trade. The other, and far more pressing, is about what money could enter or leave the country after a Brexit.

The flow of money

When major economic events occur that unsettle the status quo, investors become nervous. It doesn’t matter where they are, or how much money they have. Once uncertainties take hold, they are far more likely to take their money out of risky investments – for instance, stocks – and put them into much safer, long-term holdings such as bonds.

The “Brexit” certainly satisfies all the criteria for a major economic event. Even though a British departure from the EU might not be as shocking as, say, the 2008 financial crisis, we can expect to witness similar fluctuations in monetary movements.

Consider that in 2008 the Australian banks were quite insulated from the negative effects of the crunch. They still experienced sell-offs. A British exit would see the same.

The first thing we can expect to see is that money will move outside of “risky” investments like stocks. This will likely have a downward effect on the sharemarket – not very good news for anyone depending on superannuation funds. It’s also relatively bad news for an already terrible year in stocks. A British exit could make an already average year a little worse.

Unfortunately, stock sell-offs carry a deflationary consequence. Inflation is already low in Australia, which has forced the Reserve Bank to lower interest rates – some expect it to do so again regardless of whether Britain exits the EU. Deflationary pressure from Britain would likely put even more pressure on the RBA.

That might be great news for mortgage holder. It’s not great news for investors, anyone saving for a deposit, or those hoping for a jolt to the Australian economy. Lower interest rates discourage investment, which is exactly what Australia needs in the shift to a modern economy away from the mining sector.

Speaking of mining, there’s another key point that could impact the Australian economy should money leave risky investments – commodity prices. Interest rates are heavily dependent on fluctuations in commodities, and downward movements in this area would even put more pressure on the RBA. This is also bad news for either a Labor or Liberal government, either of which might hope to see commodity prices rise in order to help the Federal Budget bottom line.

Oil prices could also decline. While this may not have a huge effect on the Australian economy, the negative effects on oil-based economies could trickle down under.

The bottom line: should a Brexit occur, businesses and investors will grow less confident of a good return in Britain. Expect a move from high-yield to low-yield investments, which will put deflationary pressure on the Australian economy and pave the way for lower interest rates.

The consequences for trade

The second way a Brexit could affect the Australian economy is much less clear, but likely far more relevant to SMEs. Britain isn’t Australia’s largest trading partner, but it’s a significant one, and business decisions made by British businesses could have consequences for local companies, both big and small.

In this case, businesses need to consider on an individual basis how much risk they’re willing to hold when it comes to their British trading partners.

There are, of course, strategies businesses can take to influence how exposed they are to this risk. Reducing or avoiding trade with British businesses for a temporary period can ensure limited exposure to any negative economic activity, but many businesses in long-term contracts are unlikely to have the freedom to exit binding contracts.

Currency hedging is more of an effective method for businesses to insulate themselves from risk. While it isn’t a silver bullet, hedging currencies during uncertain times can give businesses at least some certainty over their future and allow them to make informed business decisions, rather than being terrified into making no decision at all – an unfortunate consequence of global economic uncertainty.

If you own a business operating in or trading with British partners, it’s important to consider just how much risk you would like to take on. Evaluate your trading partners, speak with them about what impact they are likely to see, and adjust accordingly.

The bottom line? Businesses need to create as much certainty as they can for themselves during this uncertain time. Currency hedging is one way to do this, but businesses should also understand just how much risk they’re willing to take on given the financial health of their business.

But it’s not all negative. While a Brexit may spell out some negative economic consequences, there are always opportunities for Australian SMEs to thrive.

William Shepherd is Treasury Manager for the global OFX group. OFX (formerly OzForex) is an international money transfer service and provider of in-depth commentary, forex news and insight, and expert market analysis.