THE U.K. HAS SPOKEN: OUT OF EUROPE
U.K.’s vote to leave the European Union kicks off a long period of political, economic and market uncertainty for the U.K. and for the E.U.
We should now expect for European leaders to focus on fending on further uncertainty and market distress following the British exit and on preventing the entire EU from falling apart.
The decision to Brexit could accelerate the retreat from political and economic consensus around the world.
As Britain’s exit from the EU should be messy and costly for both parties, both parties will have to take extreme steps to ensure the affects of the historic event don’t ruin the future of their existence. Economists are slashing their forecast for Britain, with some expecting a recession and next to no growth next year. That is a sharp reverse for an economy that had been among the best-performing in the developed world in recent years.
The Europeam Union is the UK’s most important trade partner, accounting for half of all UK imports and exports. UK exports to the EU correspond to almost 15% of national output (GBP).
EU membership matters to the UK economy primarily because it leads to lower trade barriers. This makes goods and services cheaper for UK consumers and allows UK businesses to export more.
Leaving the EU will lead to lower trade between the UK and the EU because of higher tariff and non-tariff barriers to trade.
The main benefit of leaving the EU would be a lower net contribution to the EU budget. On the long-term, this might actually make the UK economy stronger as it will not suffer because of ‘weaker’ EU members who need funding. Besides the economic regulations being changed once they exit, the immigration regulations will change as well, what has proven to be quite important for the majority of the ‘Leave’ voters, if not the ultimate reason.
Although the chance of an economic crisis following a Brexit was factored in, the backlash against immigration, fueled in part by homegrown Islamic terrorism in Europe and the U.S., overshadowed the ‘short-term’ economic damage. Britains support globalization of goods and capital, but not people and regulations.
The BoE’s first priority is to provide enough liquidity to avoid any funding stresses. The strong plunge and volatility of the pound will likely cause the central bank to cut its 0.5% policy interest rate to zero soon, and lean more towards quantitative easing rather than pushing rates into negative territory.
The largest risks in the foreign-exchange markets involve economies reliant on the U.K., while the biggest beneficiaries are likely to be the traditional safe-havens, the dollar and the yen.
Brexit spurred leaders of far-right populist parties in the Netherlands and France to reiterate demands for referendums on those countries’ membership in the EU, which would revive yet again the threat of a euro breakup. This puts pressure on the EUR as uncertainty takes over, making investors shift to safer assets like Gold.
The drop in stocks is a sign of new risks surrounding the global economic outlook.
Our outlook for the long-term is the following;
As investors sentiment will take a left turn and investors will be less willing to invest in risky assets that push economies up, the growth of global markets and economies will look less promising and therefore keep the Federal Reserve from raising interest rates as planned this year, and even spark a new round of emergancy policy easing from major central banks.
This will put pressure on the USD but not as much pressure as will be put on the EUR, as the EU’s future is being questioned.
Our analysis suggests that EUR/USD should go further down, targeting 1 (currently at 1.1).
Gold and JPY, being the ‘go-to-safe-havens’, should attract more investors and are expected to make nice bullish moves up.
The financial shock of last week’s Brexit vote will eventually fade, but it is unlikely to be the last as the domino effect will cause a wave of shocking events.