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The Brexit referendum increased uncertainty regarding future trade conditions between the UK and EU. This column analyses the impact of Brexit trade policy uncertainty on UK import prices. It shows that relative import prices of goods exposed to a higher risk of tariffs co-moved with the expected Brexit probability before the referendum.
Inflation has become a concern for policymakers worldwide. Its potential causes include geopolitical tensions, supply chain disruptions, expansionary monetary and fiscal policies, and rising commodity prices (Ilzetzki 2022). This has also been an issue in the UK, which has experienced higher inflation than other G-7 economies, and raised the question of whether and how Brexit has contributed to rising prices.
There are different channels through which Brexit can affect price levels. One source is the pound devaluation, as Breinlich et al. (2022) find. Our research highlights an alternative source: the trade policy uncertainty (TPU) associated with Brexit. Specifically, we find that uncertainty about the future trading conditions with the EU increased the UK's import prices from the EU-27, with the leave referendum raising those prices by as much as 10%.
The opportunity to vote for Brexit in the 2016 referendum increased uncertainty about the future trade conditions between the EU and the UK. In 2013, the UK Prime Minister David Cameron raised the possibility of a referendum on the EU and announced he would follow through after the Conservative election victory in May 2015. As the June 2016 referendum approached, 83% of UK Chief Financial Officers (CFOs) reported high uncertainty, as did CFOs in Ireland (55%), the Netherlands (69%), and Germany (93%) (Deloitte 2016). UK CFOs ranked the Brexit referendum as the number one risk to their business over the next 12 months in 2016Q1. Similarly, two-fifths of CFOs in Europe ranked geopolitical risks as the first or second most important risk factor.
With the UK's membership status in danger, firms in other EU countries had to make investment decisions without knowing whether they would continue to have duty-free market access. Export investments include setting up distribution networks, acquiring consumers, matching quality to foreign tastes and product standards to regulations, as well as learning customs procedures. These investments in export capital cannot be easily recovered when market conditions worsen, for example if tariffs or other trade barriers increase....
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