Brexit D-Day—Turmoil and Uncertainty
The U.K. voted to leave the EU by 52%-48%, with a high turnout of 72%. The market reaction has been violent given widespread expectations for a REMAIN victory. Analysts are starting to release their assessments.
The facts (see EuroIntelligence for example):
Referendum results—The UK voted to Leave the European Union, with final results showing a 51.9% lead for Leave vs 48.1% for Remain, with high turnout (72.2%) (see Bloomberg’s turnout map).
Market reaction—The Leave outcome has led to a market correction this morning. European equity markets reacted violently to the Brexit vote with losses of around 5% to 11% midsession Friday. The pound is down 6.5% to $1.390, a level not seen in 30 years, and even reached a low of $1.3229 or a 12% peak-to-trough move.
Political turmoil—David Cameron announced its decision to stand down as Prime Minister (see statement)—by the time of the Conservative Party conference in October. Iain Andrerson (Cicero) looks at the political implications of the referendum. A Scottish referendum can be expected, called for by the Scottish First Minister (speech).
Next steps—The exit process will have to be formally activated (probably in the autumn) via Article 50 of the EU Treaty, opening a 2-year process of withdrawal.
The results were followed by a host of statements by head of States (France, Germany, US) or institutions (IMF, G7, European Council, Bank of England, ECB, Goldman Sachs to its staff) respecting (though mostly regretting) the outcome but signaling willing to work towards a construction transition and exit. The heads of EU institutions asked the UK to launch exit negotiations and present its proposal for future cooperation as soon as possible (joint statement). Wolgang Munchau (FT) writes that the referendum outcome reflects a much overlooked aspect of the political economy of the modern EU: it is not sustainable for a member state of the EU to be part of the single market but permanently not part of the eurozone, especially as the single market is no longer a force for unity but division.
The immediate policy response: Central banks as the first line of defense—The BoE stated that it will "support the functioning of markets", including through the operation of its normal liquidity facilities and will assess if further policy response is needed in the coming weeks. The BoE is prepared to activate swap lines with other major central banks and conduct additional liquidity operations, including the provision of term funding for UK banks. These announcements should help mitigate foreign exchange volatility and support bank funding (including in foreign currency). Market analysts, including Goldman Sachs (for its assessment of the result, including its near-term market consequences, see here), among others, provides a review of the implications of the vote., expect credit easing at the July 14 MPC meeting, followed by a rate cut in August. The ECB (statement) will provide additional liquidity, if needed, in euro and foreign currencies and is closely monitoring financial markets. Scandinavian central banks have issued similar statements.
A series of emergency meetings are scheduled—On June 24 (between the heads of EU institutions, between G7 deputy finance ministers, between EU foreign ministers), on June 25 (foreign ministers of EU founding members), on June 27 (between Tusk, Hollande, Renzi and Merkel in Berlin) and on June 28 (European leaders will meet without the UK in Brussels on the sidelines of Tuesday’s regular European Council).
Uncertainty as the key channel—For Goldman Sachs, macroeconomic policy uncertainty (see also Roger Cohen in the NYT) is a key channel for the Leave decision to weaken the UK’s growth outlook, with implications for the rest of Europe (spillovers through trade, financial and confidence channels). S&P is preparing a rating downgrade for the UK. James Strong (LSE) sees four questions to be resolved: (i) when will the Brexit negotiations begin? (ii) what sort of mandate does the leave camp have? (iii) what sort of deal will parliament approve? and (iv) what happens if there is an early general election before the two years are up? Erik Nielsen (Unicredit) and William Buiter et al. (Barclays) insists on the many sources of political uncertainty—who will be the next prime minister, will conservatives split, will national elections be organized, will there be another referendum on Scottish independence, and maybe even one for Northern Ireland, a point also made by David Marsh (OMFIF) (Scotland and Northern Ireland voted in favour of the EU (with 62% and 55.8% shares of the vote, respectively), while Wales (52.5% Leave) and England (53.4%) voted the other way as reported by Citi). Marsh notes that unprecedentedly, the British people, as the ultimate sovereign, have given instructions to the government and parliament to carry out actions with which the majority of the present government and parliament disagrees.
Nielsen sees a high probably for a technical recession as result of a sharp fall in UK risky asset prices, delays to investment, disruption to trade, and a loss of business and consumer confidence. Citi notes that banks are especially exposed to Brexit with a series of first-order (passporting), second-order (slowing loan demand, higher cost of funding, deterioration in asset quality) and third-order (Scotland exit) risks.
For Martin Wolf (FT), Brexit will reconfigure the UK economy—as it reflects a revolt of the provinces against a prosperous and globalised London, against the establishment — political, economic and commercial. Despite uncertainty, he sees as unavoidable that the UK will bring in controls over immigration from the EU, which will rule out membership to the single market. The reconfiguration of the UK economy will see a reduced role of the City, and a relocation of many manufacturers.
A sharp drop in the value of sterling (Erik Nielsen even estimated that portfolio flow reversal would send EUR-GBP to 0.90 and result in sustained GBP-USD weakness to between 1.25 and 1.30), pushing up inflation, will leave the BoE facing a trade-off between stabilizing inflation on the one hand and output on the other. Citi (here) provides further analysis on the political and economic implications of the vote for the UK, Europe and rest of the world.
Analysts also speculate about second-round political risks in the EU. David Marsh (OMFIF) worries that the vote could encourage centrifugal forces from Portugal to Poland and from Italy to Ireland, and particularly in the EU’s heartlands of France and Germany – sharing a disquiet over high immigration and sluggish growth, desire for self-government, and widespread belief that leaders are out of touch. This was largely relayed in the German press (hat-tip EUO’s German News) for example, with Sven Afhüppe (Handelsblatt Global Edition) and Ruth Berschens (commentary) arguing that the Brexit vote will have serious political fallout in Germany, making business as usual not an option anymore. For Patrick Bernau (FAZ), this reflects increasing mistrust between the elites and large parts of the population. Gabor Steingart (Handelsblatt) writes that this sends strong warning signs to a Brussels that has become a symbol for administrative arrogance and feudalism.
