A deeply-divided UK has made its choice; 51.9% of the electorate voted to leave the EU in a referendum held on 23 June. The vote will have both short- and long-term economic consequences.
Investors will be quick to price uncertainty. The shock to equity and currency markets (GBP is expected to lose at least -10% this year) will impact private consumption and investment in Q3 and Q4. The risk of recession in H2 2016 is high. Expect GDP growth to slow more sharply in 2016, to +1% from +2.3% in 2015.
In the longer term, economic activity will be impacted in a more profound way. A series of indicators, including GDP growth, exports and foreign investment may narrow, given the uncertainties related to the outcome of negotiations with the EU. Company turnover and margins will also reflect the new reality. Add to that a hike in the number of insolvencies (from 1,500 to 1,700 cases between 2017 and 2019).
The official exit may occur in early 2019 but an extension of the two-year European procedure is not excluded. In a soft leave scenario, in which the UK signs a Free Trade Agreement (FTA) with the EU, real GDP growth could fall by -2.8pps between 2017 and 2019. In a hard leave scenario (no FTA) a -4.3pps cumulative shock could occur (see also our Brexit focused Economic Insight).
Steady as she goes?
Beyond the UK’s borders, financial markets’ initial reaction was strong. The peak depreciation of the GBP was -10% and many financial stocks decreased by -20%. Yet pledges from Central Banks to provide the necessary support helped to alleviate some of the anxiety.
The Bank of England pledged to provide "more than GBP250bn through its normal facilities” to the financial sector if needed. Moreover, key world Central Banks (including the ECB and the BoJ) stand ready to activate their currency swap-lines and support liquidity.
Meanwhile, two clear short-term effects materialized.
First, safe havens benefited. The USD appreciated by +2% in effective terms, the JPY/USD appreciated by +3%. 10-year bond yields hit new lows in the U.S. (1.5%), Germany (-0.05%) and in the UK (1.1%, -30 bps). The Yen’s continued rally adds pressure on the authorities to act.
Second, 10-year yields increased in “riskier” economies in the Euro Area, with Portugal (+30bps), Spain (+12bps) and Italy (+10bps). But these yields still remain below 2015 levels.