From Our Briefings Newsletter
The article below is from our BRIEFINGS newsletter of 27 June 2016:
Briefly . . . After the Brexit Vote, Where Do We Go From Here?
The UK's vote to leave the EU sets in motion a series of complex adjustments for the UK and Europe that will take years to play out. To analyze the economic and market implications, we sat down with Goldman Sachs Research's Huw Pill, chief European economist, and Peter Oppenheimer, chief global equity strategist.
What is the immediate effect of the UK referendum? What happens next?
Huw Pill: The most immediate effect is the rise in uncertainty, both political and economic. UK Prime Minister David Cameron said he will leave the formal process of serving notice to exit the EU to his successor, which leaves some time before the difficult task of negotiating an exit will begin. Political and economic uncertainty will be with us for a long time and will weigh on markets and growth.
How much of a blow to growth do you expect?
HP: We see the strongest impact in the UK itself, where we revised our real GDP forecasts lower by half a percentage point in 2016 and 1.8 percentage points in 2017. This implies a mild recession by early 2017. We have also reduced our Euro-area GDP forecast by a cumulative half percent for the next two years, and have shaved our US GDP forecast for the second half of 2016 by a quarter point to 2%.
How will central bankers respond?
HP: The Bank of England will likely ease policy via a combination of a quarter-point rate cut, renewed corporate bond purchases and an expanded Funding for Lending scheme meant to increase bank lending. We now expect the ECB to exploit flexibility in its Asset Purchase Program to frontload purchases and to continue the program through 2018. The likelihood of more aggressive easing measures by the ECB has also risen and could be easily justified not just by the Brexit shock but also by the existing shortfall in inflation versus its mandate. For the Federal Reserve, the referendum has effectively taken a July rate hike off the table and reduced our subjective likelihood of a September increase to 25%.
Where does that leave markets? Will the turmoil we saw immediately after the referendum continue?
Peter Oppenheimer: Volatility in the currency market will likely continue. The British pound weakened significantly when the results became clear, and currencies that are seen as "safe havens" such as the Japanese Yen and Swiss Franc rallied. In government bond markets, yields that were already low moved still lower on a "flight to safety." Stocks fell around the world. We see this as consistent with our view that globally stocks are stuck in a "fat and flat" range of relatively low returns within a wide trading band. Elevated valuations across equity markets, in part a result of the intense search for yield, and lack of growth have made equities more vulnerable to shocks such as Brexit. A key concern remains the lack of diversification or availability of "hedges" for equities as most safe assets, in particular bonds, remain expensive alongside equities.
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