The UK’s 52% to 48% vote to break with the European Union (EU) has lasting consequences for the UK, Europe and the world at large. With UK Prime Minister David Cameron set to leave his post by October, we believe other European leaders will be focused on fending off populist movements throughout the continent, spurring further political and economic uncertainty. We see five key takeaways from this historic decision.
The exit process won’t be an easy one. We believe the UK’s departure from the EU will be a long and complicated process as officials sort through UK and EU laws. The UK will have to strike new trade deals with the now-spurned EU and with the rest of the world. The resulting potential losses in services exports and investment flows will likely overwhelm any benefits of lower payments to the EU.
Scottish independence is back on the table. Prime Minister Cameron’s departure sets the stage for a Conservative leadership election, dominated by Leave supporters, this summer. This could make for volatile EU exit negotiations and set the stage for another independence attempt by Scotland.
A weaker euro is likely over time. We also see pressure on European shares, credit and peripheral bonds. We believe pressure on government budgets will be limited as high-quality government bonds are very much in demand in today’s low-rate world.
The Bank of England (BoE) will react accordingly. We believe its first priority will be to provide the liquidity necessary to prevent any funding stresses. The magnitude and volatility of the British pound’s decline will likely dictate further responses. What’s more, we expect the BoE to cut its 0.5% policy interest rate to zero soon, choosing to return to quantitative easing instead of pushing rates into negative territory.
Global implications vary. While the vote will likely lead to declines in global shares and other risk assets, we do see indiscriminate selling potentially paving the way for opportunities. U.S. and Asia markets are only marginally affected by the British exit from the EU and are supported by a mix of easy monetary policy and economic growth. A UK currency drop will benefit large companies with overseas earnings, but domestic sectors such as homebuilders, retail and financials do look vulnerable.
For more on this, read my full report, UK Vote: Out of Europe.
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