Sterling and financial markets tumble as Britain votes to leave the European Union
27/Jun/2016 • Currency Updates•
British voters surprised the consensus of strategists and voted to leave the European Union by a margin of 52% to 48%.
The fallout from this unexpected result rocked financial markets worldwide on Friday, sending stock markets down from 3% to 13%. Significantly, Italian and Spanish shares suffered the most with double digit losses, while US stocks indices held up relatively well, down just 3-4%.
Currency markets saw extreme volatility. Sterling experienced the biggest one-day fall in history, down over 10% against the US Dollar and 7% against the Euro. The greenback and, in particular, the Yen were the biggest beneficiaries of the turmoil, rising sharply against almost every major currency in the world.
Last week’s EU referendum is perhaps the single most important political event in Europe of the last few decades. It’s more difficult than ever to make predictions. Conservatives and Labour are both in temporary disarray, with the Prime Minister, David Cameron, resigning and Corbyn’s leadership seriously questioned. The Leave camp does not have anything like a programme for managing the negotiation process. However, it is possible to list some key factors that will shape and constrain political, economic and financial events over the near and medium term.
Timing: The UK will continue to enjoy EU membership for two years after it informs the European Council that it wishes to leave. It has not done so yet, nor is there any sign that it will soon. The delayed resignation of Prime Minister Cameron ensures that the UK will not formally confirm it’s intention to leave for a few months and it is unclear whether anyone in the Conservative Party has both the will to do it and enough party support. The EU cannot force the issue. Therefore, it is important to note that no significant legislative change will take place for quite a long time.
Scotland: Scottish nationalists will almost certainly hold a second referendum if and when UK the exit is officially confirmed. Early polls confirm that support for independence in Scotland has risen since the EU referendum. There will also be serious legal difficulties in executing the exit process without the approval of the Scottish and Northern Irish Parliaments. This too points to protracted wrangling without any immediate change.
Economic fallout: It is clear that the short term impact will be negative. There is little chance of the UK economy delivering on the roughly 2% growth that most economists had expected in 2016. Forecasting actual growth is particularly difficult right now. We expect to see a significant fall in investment and, particularly, construction. However, the fall in Sterling should be compensated somewhat by reducing the trade deficit. The first reliable indication of the impact on investment will be known in the July PMI surveys, out in the first week of August. Expect renewed volatility around these dates.
Financial stability: It appears that the financial system has so far borne the turmoil reasonably well. The Bank of England has made it clear that it stands ready to guarantee stability. It will provide £250 billion in additional liquidity and is ready to offer Euros, US Dollars and Yen, if necessary, with the help of the corresponding central banks. We are confident that there will be no major financial accidents to worsen the delicate situation. Nevertheless, we expect very volatile markets in the days ahead.
Other major currencies:
FX markets have rightly focused on the impact of the referendum on the UK and Sterling. However, in our opinion, the economic fallout in the Eurozone has been underestimated.
Already we are seeing calls in other European countries for a similar exit referendum. In particular, the development of the institutional infrastructure to support the Euro (unified banking regulation, deposit insurance, etc) has been made considerably more difficult.
Even after last week’s sell off, we think current EUR/USD levels still don’t sufficiently reflect the worsened political backdrop and we expect to see the common currency trend considerably lower than current levels over the next weeks and months. As this is written, the markets appear to be agreeing with us subjecting the common currency to further punishment against the US Dollar during Asian hours.
As in the case of the UK, the first real measure of the negative economic and financial fallout will come in the investor and business manager confidence surveys out 22 July. We will keep you posted.
The immediate consequence of the UK referendum in the US is that a Federal Reserve interest rate hike in July can be ruled out.
Whether we see any hikes at all in 2016 now depends on the evolution of the global economy and financial markets over the next quarter. It seems, however, that the US Dollar has decoupled from Fed expectations and has become a safe haven.
Therefore, we see no need to change our positive forecasts for the US Dollar and, in fact, may revise them higher, particularly against the Euro.
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