19  All speeches are available online at www.bankofengland.co.uk/speeches  19  labour that result from Brexit – both effective and actual – should steepen the wage Phillips curve, increasing the sensitivity of domestic wages to domestic labour market slack (moving in the opposite direction to the rotation shown by (3) in Figure 1 above). UK potential supply capacity itself is also likely to be lower as some capacity tied to Europe becomes obsolete. The reduction and reorientation of trade is likely to weigh on productivity for some time through a loss of comparative advantage and the disruption of supply chains as companies in the UK shift from supplying customers in the EU to customers in the rest of the world. Empirical estimates suggest a 20% reduction in trade tends to drag on productivity by around 5% in the long run. 53  The actual impact will  depend on how quickly any lost access to European and third country markets (via European trade deals) can be replaced. In this regard, the UK Prime Minister’s discussions in Canada today are potentially significant. With respect to the exchange rate, the effects of imported inflation are particularly important to UK inflation dynamics, given both the openness of its economy, the low degree of home currency invoicing  54  and the  relatively slow but significant pass through of large, persistent exchange rate moves.
The UK has begun the process of redefining its relationship with its largest trade and investment partner. To be clear, the intention is not to turn inwards but rather to increase openness over time. In particular, the UK government’s objective is a “comprehensive, bold and ambitious free trade agreement with the European Union.” Leaving the EU is intended to enhance the UK’s ability to strike trade and investment agreements with a wide range of countries beyond those covered by virtue of its membership of the EU. But Brexit is an example of reculer pour mieux sauter. 44  That’s because any reduction in openness with the  EU is unlikely to be immediately compensated by new ties of a similar magnitude with other trade partners. And even if new agreements with other partners could be struck instantaneously, the reorientation of business relationships will take some time. This makes Brexit, relative to the experience of the past half century, unique. It will be, at least for a period of time, an example of de-globalisation not globalisation. It will proceed rapidly not slowly. Its effects will not build by stealth but can be anticipated. Let me turn to those effects. The first is the obvious disinflationary impact of Brexit given that the EU takes 44% of UK exports.