Impact of Brexit
1. The trade channel: over time, the UK will become less open to trade with each EU member under any new type of trade agreement. Currently, around 50% of the UK economy’s exports are shipped to Europe. The immediate short-term impact will be a reduction in external demand and lower investment spending. In the longer term, the economic impact is more uncertain and could possibly be positive, given the freedom to negotiate pro-actively free trade agreements.
2. The uncertainty impact: uncertainties will increase as we enter uncharted territories. A new agreement with the EU could take several years to negotiate and each individual Member State will have to ratify the final agreement nationally. New trade agreements will also have to be negotiated with each non-EU State. Households and corporations could delay spending and investments as a consequence.
3. The financial impact: market volatility is likely to rise and financial conditions are likely to tighten. The depreciation of the pound will generate imported inflation with important consequences on monetary policy. Currently, the UK current account deficit remains huge, as the economy relies on the ‘kindness of strangers’ to finance that deficit. The major central banks are likely to provide ample liquidity to banks to assure a smooth functioning of financial markets.
Despite these headwinds, we remain optimistic about the medium-term outlook for the European Union. In particular, the European Central Bank (ECB) conducts an expansive monetary policy to keep interest rates low and to spur private investment in the Eurozone. This policy will also maintain narrow interest rate spreads for peripheral countries. With regards to the economic outlook, credit growth will remain supportive and a lower euro will benefit exporters.
In the event of rising financial tensions, European institutions are in place to preserve financial stability. In this environment and even though these markets are difficult to navigate, we are confident that opportunities will arise from market’s overreaction to the news.