Chase's Chief Economist Offers Views on Brexit
On Thursday, June 23 the United Kingdom voted to leave the European Union in response to a highly anticipated referendum with important consequences. Below, Anthony Chan, chief economist for Chase, discusses BREXIT and its implications.
The vote is over. How quickly will the exit process take place?
Once a country invokes Article 501 of the European Treaty, the clock starts ticking and a country must complete its negotiation process within two years. Any final agreement reached would then have to be approved by a qualified majority vote of European leaders, a majority of the European Parliament and by the parliaments of the 27 remaining European Union countries.
What political changes can we expect within the UK?
Prime Minister David Cameron stated that he would resign as Prime Minister if BREXIT was the outcome. The prevailing consensus is that Boris Johnson (a Conservative MP2 and London's former mayor) would be a leading candidate to replace Mr. Cameron.
Others worry that Northern Ireland and even Scotland may decide that they want to remain a part of the European Union, and may therefore seek to break away from the UK to make such desires a reality.
What economic impact should investors expect as a result of the UK's exit from the European Union?
J.P. Morgan's Private Bank expects UK GDP to slow moderately to near-zero but to avoid a recession. As for Europe as a whole, the BREXIT outcome will likely shave off roughly a quarter to half a point of current GDP estimates, which stand at 1.5% – 2.0%.
Why is there even a possibility of a negative impact on UK real GDP growth?
The UK exports nearly 44% of its total exports to the European Union without having to worry about excessive tariffs or other restrictions. While many have noted that other countries outside the European Union trade freely with the European Union with few constraints, there is a strong possibility that the UK could enjoy the same status but only after a period of negotiation. This process, in our opinion, could take anywhere from three to five years and therefore may dampen growth in the interim.
Along similar lines, what could be the impact on U.S. and globalfinancial markets?
On the equity front, JPMorgan Private Bank expects that European markets could experience a short-term market correction of 5% to 10% while U.S. equity markets could experience a market correction that would be about half that amount.
Within credit markets, it would be reasonable to expect that the increased market turbulence would push global and domestic interest rates even lower than current levels.
Nonetheless, we strongly believe that once financial markets receive greater clarity regarding the settlement of trade and other important economic issues, they will be able to bounce back from their initial decline.
Is it possible to see negative spillover effects in the Eurozone?
The Spring 2016 Global Attitudes Survey from the PEW Research Center found that the UK is not the only European country with an unfavorable view of the European Union. The survey found that as many as 71% of the Greek electorate had an unfavorable view of the EU. Other countries with high unfavorable ratings of the EU included France at 61%, Spain at 49% and even Germany at 48%. Interestingly, the UK only matches Germany's unfavorable rating of 48%. Such high unfavorable readings would suggest some threat to the EuropeanUnion itself, which could be reflected in a weaker British Pound and ultimately in a weaker euro. It is widely agreed that if European currencies were to weaken versus the U.S. dollar, it would hurt many S&P 500 companies that generate close to 50% of their revenues from overseas business activities.
Against this backdrop, what can we expect from major Central Banks?
In the days leading to the vote, numerous stories speculated that the Federal Reserve, the European Central Bank and the Bank of Japan would likely move in a coordinated manner to inject financial markets with additional liquidity to offset the destabilizing effects of such an outcome. The Bank of England is expected to follow this voting outcome by reducing short-term rates and has announced it will do whatever is necessary to calm UK financial markets.
While BREXIT may bring considerable uncertainty in the short run as reflected in global and domestic equity, credit and foreign exchange markets, we encourage investors to remain focused on the long-term economic fundamentals.
Although we were not surprised to see an immediate negative reaction within financial markets after the election outcome, we strongly believe that once market participants get a better idea of the transition process and receive greater clarity on the path of the negotiations, they will recover and put this issue behind them.
Finally, investors should rest assured that major central banks would likely stand prepared to move in tandem with one another to add a large amount of liquidity into financial markets to offset any sense of panic.
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Anthony Chan is the Chief Economist for Chase. Anthony joined JPMorgan Chase in 1994 from Barclays, where he served as a senior economist. Before that, he was an economist at the Federal Reserve Bank of New York.