It looks like central banks in Canada and the rest of the advanced global economies did what they needed to do to manage the first day of a post-Brexit world – which, as it turned out, wasn't much. But even if a feared financial market meltdown has been averted, the harder part of the job for central bankers in the Brexit fallout is yet to come.
Within a few hours after British voters had narrowly elected in a referendum to exit the European Union, the central bank bosses of the Group of Seven countries – including Bank of Canada Governor Stephen Poloz – were on a conference call (along with those countries' finance ministers), discussing what actions were needed to make sure the financial market sell-off already under way didn't escalate into a calamitous meltdown. They settled on a joint statement, issued before the North American markets opened, reminding the world that they were on the job – ready with co-ordinated liquidity injections to keep the markets moving and the money flowing, should they be needed.
In Britain, where the pound had already plunged more than 10 per cent overnight on the vote result, Bank of England Governor Mark Carney was understandably stronger in making that point. He said the BoE was poised with more than £250-billion ($445-billion) ready to make available to banks, and additional "substantial liquidity" in foreign currencies, if things started to look ugly.
Toss in an overnight pledge from the Bank of Japan to provide liquidity if necessary to stabilize foreign exchange markets, and a currency intervention by the perpetually currency-conscious Swiss National Bank, and that was all that was needed to ride out the early Brexit panic. After the initial dramatic selling, and despite the generally negative tone, it turned out to be a remarkably composed day of trading. And central banks were able to save pretty much all their ammunition for another day.
In the post-financial-crisis world, the major central banks are better prepared to cut off market upheaval at the pass. They have systems in place to quickly inject funds into the banking system and financial markets. The central banks of Canada, the U.S., Britain, Japan, Switzerland and the EU also have standing "liquidity swap arrangements" to help the markets ride out currency volatility. The mere reminder that the central banks had these tools in hand seemed enough to reassure markets.
That might actually be enough. This is market turmoil not driven by some underlying malfunction of the financial system that's likely to cascade upon itself – like, say, the 2008 financial crisis – but rather by fear of the unknown. Despite this defensive rush to reduce risk exposure, there was no evidence that markets were seizing up on Friday. It looked like a repricing, not a meltdown.
"While consequential, this does not appear to be a Lehman moment," RBC Global Asset Management chief economist Eric Lascelles wrote in a report.
But Lehman moment or not, a significant repricing of global markets could meaningfully redraw North America's near-term economic road map – quite apart from direct economic impacts from the Brexit result. (Canada, which relies on Britain for just 3 per cent of its exports, doesn't have much direct exposure to a potential Brexit-related economic slump in Britain.) If Friday's market revaluing sticks – or, as is quite possible, deepens in the coming days – it could throw a big wrench into the best-laid monetary policy plans of the Bank of Canada and the U.S. Federal Reserve.
The pivotal element here is the flight to safety in the U.S. dollar, which was abundant on Friday. U.S. exports have already suffered a considerable drag from the strong American currency, and that has been a significant factor in holding back the U.S. recovery this year. Another round of greenback appreciation, especially if coupled with any slowdown in demand from an uncertain Europe, could deepen the U.S. manufacturing funk and further undermine growth.
That's certainly on the radar of the Fed, which had cited the Brexit vote earlier this month in its decision to hold off on another interest rate increase – a position that looks very prudent indeed today. Before the Brexit vote, the bond market was pricing in about a 30-per-cent chance that the Fed would raise its key rate at its September meeting. By midday Friday, the likelihood of such a hike had been reduced to zero – and the market had priced in a 12-per-cent chance that the Fed would have to cut.
The well-being of the U.S. economy is, in turn, critical for Canada's own economic prospects. Rising U.S. demand for Canadian non-resource exports is the linchpin in the Bank of Canada's outlook for an economic resurgence. At very least, that has come into question.
Further complicating matters for the Bank of Canada will be the impact of Friday's downward shifts in both oil prices and the Canadian dollar. A lasting deterioration in oil would protract the slump in the country's oil-producing regions. A weaker dollar might give the country's non-resource exporters a competitive lift – but demand, both in the U.S. and overseas, may be less robust than hoped.
These are nothing, of course, compared with the questions faced by the Bank of England and the European Central Bank in the coming months, or likely longer. They have been thrust into the great unknown, and it's impossible to say how hard they will have to lean their policy against the uncertainty and turmoil ahead as Britain and the EU rewrite their complicated relationship. There will be tremendous pressures from some fronts to get out ahead of the game and ease monetary policy. That tide may well reach North America's shores – and remarkably quickly if financial market confidence falters.
It's incumbent on the central bank leaders to separate economic reality from market turmoil. After all, the Brexit vote changes nothing in terms of global trade flows and underlying aggregate demand in the near term – only perceptions have been shaken, not the world's economic fundamentals. The appropriate response, until we know a lot more about the economic fallout than we know now, is to remain prepared to be quick and responsive with market liquidity if needed, but slow and patient on interest rates.