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ECONOMY: BREXIT - UK’s 2016 Growth Downgraded to 1.2%


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The result of the 23rd June vote by the UK to leave the European Union has sent shockwaves across financial markets. Both short-term and long-term uncertainties are high. The GBP plunged to its lowest since 1985. Global equity markets have fallen too, Japan, Germany and France 7-8%, even more than the Footsie (-4.5%), as some stocks could not be traded when the market opened in London. Oil (-5%), gold (+5%) and the euro (-3% vs USD) also reflect this surge in volatility and global risk aversion, says Coface, the international trade credit insurance company.

In 2013, Prime Minister Cameron decided to hold a referendum if he won the 2015 general election to respond to discontent from his own Conservative MPs and the UK Independence Party (UKIP), who argued that Britain has not had a say since 1975 when it voted to stay in the EU.

In the short-term, uncertainty and volatility is likely to prevail in financial markets. The impact on business and consumer confidence in both the UK and the rest of the world will depend on the magnitude of the correction on financial markets and on political developments in coming weeks.

In the UK, if business and consumer confidence is affected by financial market volatility and political uncertainties, private consumption related sectors will be affected by increased household precautionary savings and higher inflation on the back of the lower GBP.
Business investment will take a hit as well. The construction sector could be impacted by higher prices of imported inputs. Hence, the paradox is that exporting sectors are not the most at risk in the short-term as they could benefit from the weaker GBP. All in all, this could push the Bank of England (BoE) to cut rates by the end of the year. And this has led to Coface revising down its GDP growth forecast to 1.2% this year instead of 1.8%, and 1.1% for 2017.

Domestic political uncertainties add to this risk as a conservative leadership election could take several months, Boris Johnson and Michael Gove, the two leaders of the ‘Leave’ camp in the Conservative party being the frontrunners. The UK's vote to leave may lead to calls for another Scottish referendum because Scotland voted to remain in the EU. Northern Ireland’s case could be an issue too, all the more since the region has borders with an EU country, the Republic of Ireland.

In the rest of the world and more specifically the EU, the magnitude of spill-over effects in the short-term will mostly depend on coming political developments and central bank actions. The BoE, US Fed, ECB and Bank of Japan are likely to announce common messages and action which has included providing banks with ample liquidity to avoid stress on interbank rates.

Later this year, a referendum in Italy on the constitution reform is expected and the resignation of PM Renzi is possible. Then elections are scheduled in the Netherlands, France and Germany in Q1, Q2 and Q3 of 2017 respectively.

Higher volatility and uncertainty in the short-term will be driven by long-term challenges and unknown factors resulting from the outcome of the referendum. In this regard, the key issue is the negotiation of a trade agreements between the UK and the EU. The trickiest point is the access to the single market that ensures free
movements of goods, services, capital and people.

The aim would be to make it possible for financial sector firms based in the UK to operate easily in the EU without having to comply with local regulations. According to Article 50 of the Treaty on EU, the UK has to formally announce its intention to leave the EU during the European Council where the next meeting is today 28th of June.

The UK will then have two years to negotiate a new agreement with the EU, which seems nonetheless unlikely due to the very long period usually required to negotiate trade agreements. It took seven years for Canada and the EU to settle one an agreement and it has still not been ratified. The two-year countdown could therefore be prolonged.

Three types of agreements are conceivable: (i) EEA membership, like Norway, which implies full access to the single market but loosing voting rights on regulatory framework and EU decisions; (ii) a “customised” bilateral agreement, like Switzerland, which establishes access to the single market for specific sectors and (iii) WTO rules, with existing custom tariffs and no access to the single market.

The agreement will largely depend on political choices of the future PM. This is because there is a trade-off to be done between the economic benefits resulting from the access to the single market and political/regulatory constraints. As one of the leaders of the ‘Leave’ camp is very likely to be the next PM, a Norway-style agreement is less likely and the negotiation process with the EU would be tricky. And defaulting to WTO rules means higher custom tariffs and no access to the single market. In this worst case scenario, the long-term economic cost of the Brexit would be higher:

In the UK, usual competitive exporting sectors being linked to the EU through supply chains (pharmaceutical and automotive are notable examples) will suffer from higher custom tariffs on their exports to the EU in the long-term. But on the other hand, the government could also decide to impose higher import tariffs, especially to help sectors currently suffering from foreign competition such as the metal industry. The long-term effect on the financial sector (8% of GDP, i.e. twice higher than the OECD average) is unknown at this stage.

In the EU, countries having the strongest links with the UK and comparatively small domestic markets (in terms of trade and investment) are most exposed. Ireland is by far the most at risk in this regard, followed by the Netherlands, Belgium, Denmark and Sweden, where the impact will be smaller.


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