Fabrice Montagne, Philippe Gudin de Vallerin
The likely withdrawal of the United Kingdom from the European Union following its referendum has far-reaching economic and geopolitical implications for both its domestic market and the European Union.
Below is a summary of the impacts that Barclays Research analysts anticipate in the UK and Europe, the debates that may be triggered in other EU states, and a timeline of key events.
IMPACT ON THE UK
Very short term
⇐ Sterling index depreciates by more than 10% since the referendum, to reach a multi-decade low against the US dollar.
⇐ Safe-haven assets including gold and gilts rally as investors turn risk off.
⇐ Bank of England increases liquidity-providing operations; expected to announce a 25-50bps rate cut and an extension of QE in August.
Short to medium term
⇐ Inflation set to rise faster as sterling depreciates – headline CPI to average 2.0% in 2017.
⇐ Investment to contract sharply as business face unusual levels of uncertainty.
⇐ Unemployment rate expected to move back to 6% by end of 2017.
⇐ UK fiscal targets likely to be relaxed significantly – announcement likely to be made in the government’s Autumn Statement in October.
Longer term
⇐ Annual GDP growth to drop from 2.3% in 2015 to 1.1% in 2016, and to contract by 0.4% in 2017.
⇐ UK economy to pursue its adjustment as UK and EU discussions relating to future relationship progress.
IMPACT ON EUROPE
Very short term
⇐ High uncertainty regarding the future of Europe and the political situation in some member states causes a decline in business confidence.
⇐ Bond yields in core countries remain low, reflecting their safe haven status and the ECB’s ongoing quantitative easing (QE) programme.
Short to medium term
⇐ Euro weakens against the US dollar as the economy slows and the uncertainty about the future of the currency union rises.
⇐ Populist parties campaign for debate on EU membership.
⇐ ECB extends its QE programme beyond March 2017 – announcement likely in September 2016.
⇐ Projected GDP growth in the euro area likely to slow from 1.7% to 1.4% in 2016 and 0.6% in 2017
⇐ Bond yield spreads likely to widen in peripheral countries such as Italy and Portugal
⇐ Lower business confidence leads to a downturn in business investment, a slowdown in job creation and consumer demand by end-2016, especially in peripheral countries
Longer term
⇐ Output losses across all euro area countries – both core and peripheral
⇐ Investment in southern euro area countries likely to decline – with gross fixed capital formation likely to fall 0.6% in 2017
⇐ Impact on Europe will depend on reaction by Europe’s leaders:
⁄ Scenario I
Swift action to reform a functioning EU and strengthen the single currency union could result in a reduced impact and faster resumption of growth.
⁄ Scenario II
Should European leaders focus on their disagreements and struggle to make progress – and if the political situation deteriorates in some countries (e.g. Italy in the wake of its constitutional referendum in Oct) – the downturn could turn into a renewed euro area crisis and a deeper recession.
A new debate in Europe
⇐ The UK vote to leave the EU has highlighted that voters are more willing to reject the status quo in the EU, and on economic policies implemented in member states (notably austerity, structural reforms, immigration policies) than markets have so far anticipated.
⇐ We anticipate the ‘Leave’ vote has triggered a greater likelihood of debate on the EU in other member states, including debate on the reforms necessary to improve the functioning of the union and membership of the single currency. Trends likely to arise in the coming months are:
Pressure for EU referendums
⇐ The greatest pressure for debate on membership of the EU is likely to arise in those countries with a strong populist Far Right political presence (France, the Netherlands); and those outside the single currency that viewed the UK as a strong ally (Finland and Denmark).
⇐ However, this populist drive may be offset by a swing to support for the EU, if currency, market and economic turmoil in a post-Brexit UK is seen to worsen.
Increased debate on euro membership
⇐ While many EU states may stop short of questioning their support for the union, increased debate over membership of the single currency may well arise in peripheral countries struggling economically.
⇐ Italy faces political and economic crisis if Prime Minister Renzi’s referendum on constitutional reform in September fails to achieve support and this could easily transform into support for a referendum on euro membership as 5 Star Movement leaders suggest.
⇐ In Portugal, which is under pressure to enact further public-sector austerity reforms following its EUR78 billion bail-out by the EU and International Monetary Fund five years ago, debt sustainability and euro membership could be questioned by investors.
Election debate on immigration and terms of EU membership
⇐ General and presidential elections take place in 2017 in the Netherlands, France, Germany and possibly Italy.
⇐ To counter support for the far left and right, centrist party platforms are likely to focus much more on the issue of immigration and security.
[Fabrice Montagne is Chief UK Economist at Barclays. Previously, he was a Senior European economist responsible for French, Greek and euro area macroeconomics. On the other hand, Philippe Gudin de Vallerin is a Managing Director and Chief Economist for Europe, Middle East and North Africa at Barclays. He is based in Paris and London and runs the Economic Research team for EMEA].
