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On Thursday 23rd June the British electorate voted to leave the European Union by a slender margin, a result that by Friday afternoon had many of the same electorate Googling the potential consequences of their vote.
The fall-out from the vote has been significant in both the UK and Europe. Whilst the equity markets are collapsing (Germany, France and Italy all down over 10% since last week), we are frustratingly left to wait for agreement on when exit negotiations are going to begin. This is unlikely to become clear before the process for a change in leadership has been completed and, potentially, even a general election is called in the UK. The European stance, led by the French, is crystal clear: that negotiations will not begin until Article 50 of the Lisbon Treaty is exercised. Such a measure would start the clock ticking on the two years the UK has to agree the terms of their exit. Negotiations on a future trade relationship can be part of the discussion, but are not necessary to the process and could take significantly longer. Alas, after the two year negotiation period and without some sort of agreement, the standard WTO rules will apply on trade between the two economic areas.
What is certain is that there is no hiding from the shadow of uncertainty that follows the referendum result brought to the financial markets. Nonetheless this comes at a time of greater recognition within the European Union institutions of the consequences of austere economic policies and cannot but be helpful in humbling detached institutions from the deep frustration of the people. In the coming months, regardless of what happens to the UK, a new more flexible profile will be demanded by the adhering EU members. This is likely to be led by France and Italy insisting on the deferral of the strict maintenance of deficit constraints on additional government spending arising from long-term investments in infrastructure projects.
On the economic front, protracted negotiations and the uncertainty that they create will hurt the UK‘s GDP as investments slow down. Most economists are expecting British economic growth to slow to a crawl by the end of 2016, with some also hinting at the possibility of recession. According to the ECB, the eurozone will also be impaired by the event, suffering a reduction of GDP by up to 0.5%. Central Banks have already initiated manoeuvres to counteract possible stress situations for the banking sector, but additional loosening of monetary policy, including further increases in negative interest rates are still expected. Currency depreciation could provide a sufficient boost to UK exporters, to say nothing of its inflationary implications, to persuade the Bank of England to hold off any further easing activity. However Sterling Over Night Interest Average (SONIA) rates are currently pricing in a rate cut of 0.25% in the coming couple of months.
Last week also saw the Spanish return to the polling booths, which some observers had hoped/expected would bring a great win for the Podemos Party, but eventually resulted in the same incumbent parties maintaining their stronghold of the majority of votes. This was surprising as even the exit polls predicted significant gains for the anti-austerity party; although even with moderate gains the incumbent PP is still short of a majority and will need to find a coalition partner to get parliament working, or the Spanish could find themselves at the polls again by January (the third time in a year). Numerous EU countries are now looking anxiously for the potential of a major protest vote in forthcoming elections from their own citizens.
From now on the EU will start looking at the trend in economic data and headlines regarding the course of action the UK Government will take. The latter should have probably been better prepared. It is quite striking that the Leave camp had no idea how they intended to proceed if they were to secure a result in their favour. The political situation is a shambles: deep divisions within the governing Conservative party have been exacerbated by the referendum, while the opposition Labour party is close to imploding. There is no clear path towards a stable government being formed and in place for many months. While the EU may press for early progress in the UK invoking Article 50, it has no power to enforce this and just has to wait until the UK sorts out its political disarray.
Businesses are in dire need of clarity, stability and confidence in their economic relationships. Alas, this is hardly going to be the environment for the coming months: European institutions need leaders to sit at the negotiating table, and at the moment the UK simply doesn’t have any. For all these reasons, financial markets, currencies and equity prices will continue to be on a rollercoaster. Currencies and equity will jump and fall together with the newsflow providing risk ON/OFF inputs. Crucially, we shall have to keep an eye on timings for when an application to Article 50 might be submitted.
All views expressed here are the author’s own and are based on information and data available at the time of writing.
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