"European markets have suffered more than those in the UK since the vote"by Vicky Pryce / July 11, 2016 / Leave a comment
The UK is beginning to see the first economic impacts of the shock of Brexit’s victory—as the much maligned “experts” had warned. Business investment, domestic and foreign, had weakened ahead of the vote, mergers and acquisitions activity had ground to a halt and many postponed projects were waiting for a “Remain” victory before being given the green light. Expected bounce-back is now unlikely to materialise while political and economic uncertainty remains.
We are probably entering a period of very low, if not negative growth. The pound/dollar rate fell to its lowest level in more than 30 years in the wake of the referendum result, putting upward pressure on consumer prices and manufacturers’ input costs. Online advertising for job vacancies halved in the week after the referendum, consumer and business confidence—which was already falling—looks set to fall further, and the consensus forecast for growth in 2016 has been revised down from what figure to just 1.4 per cent. For 2017 it has been revised down from 2.1 per cent to just 0.4 per cent. Though the FTSE 100 share index recovered from a sharp decline shortly after the result of the referendum was announced, various sectors have been very badly hit by the Brexit vote—housebuilding and banking in particular. There is also evidence that investors are trying to withdraw their funds from British commercial property.
But what does the Brexit vote mean for Europe’s economies? A shock to the status quo is never welcome by the markets if they haven’t priced it in. The Europe they knew has been shaken to the core. And it is not clear how it will be shaped in the future. The IMF, the OECD and others had long warned that Brexit was one of the biggest risks for global growth and financial stability. In the US, concern over the implications of the vote is already delaying interest rate rises—we may even see rates fall soon. Expect even more monetary relaxation from Mario Draghi, the head of the European Central Bank.
Lower growth in the UK is bad news for the rest of Europe too, given its trade links with the other 27 members. This will impact those countries badly although there may be some opportunities for them, particularly Germany and France, to gain some competitive advantage in areas such as banking and finance. The euro itself has strengthened against the pound by 11 per cent since 23rd June. But this may make it harder for other European countries to sell to the UK in the future. And given the inter-connectedness of business and finance, low growth in the UK and problems with its financial sector can spread rapidly across the Channel.
The underlying weakness of the European economy and its banking system has now come under the spotlight, despite it having been somewhat hidden due to support from expansionary monetary policy delivered by the ECB. European markets have suffered more than those in the UK since the vote. By late last week, shares in the main indices had fallen by some eight per cent in Germany and France, 14 per cent in Italy, and ten per cent in Spain. Italy has become a main focus of attention due to the fragility of its banking system. Its high public debt (around 135 per cent of GDP), high rates of unemployment and decades of poor growth are all taking their toll. Not surprisingly some 17 per cent—or €360bn—of banking loans are non-performing, equivalent to a fifth of the Italian economy. This is a big risk, and it does not just concern the Italians. According to the IMF, European banks are carrying around $1trn dollars of bad debt and this needs to be resolved. In addition the sustainability of the debt overhang in many countries is still in doubt.
The question of course is “What comes next?” One potential path involves acknowledging that things may have to change and that reform and mutual support may be necessary—with the offer that the UK continues trading on as good a set of terms as one can conceive of. Another would involve a group of countries pursuing further political and economic integration leaving a number of countries—particularly those in Europe’s periphery—out in the cold, with Britain being given a raw deal. At this stage nothing is clear. But in the meantime the IMF has once again revised the forecasts of eurozone growth downwards from 1.7 per cent this year and next to 1.6 and 1.4 per cent respectively. It is worried about the impact of Brexit on investment and confidence. But even that is on the assumption that a “Norwegian deal” will be reached allowing access to the single market. If not, the IMF warns that the GDP loss in the eurozone could be considerably higher. The credit rating agency Standard & Poor’s has already downgraded both the UK and the EU as a whole. Another credit rating agency, Moody’s, is warning of political risks that may result from any fragmentation of Europe as a result of the Brexit vote. Not a pretty picture.