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 Britain’s vote to leave the European Union (EU) on 23 June roiled financial markets and led to heightened risk sentiment and uncertainty globally during the following week. Based on the reaction of financial markets between the referendum and 1 July, Brexit is expected to be negative for UK growth, moderately negative for euro area growth, neutral for other advanced economies and mixed for emerging markets (EMs).

First, the UK. There are concerns about the UK’s large current account deficit, that investment may be held back, and that trade could deteriorate all leading to lower UK growth. These concerns are reflected in financial markets. The British pound had sold off 10.8% by 1 July as uncertainty around the outlook for the UK increased. On stock markets, although the FTSE 100 recovered its initial losses, this does not give the full picture. The FTSE 100 is dominated by large multinational companies that generate a large amount of revenue from outside the UK and are, therefore, relatively insulated from Brexit. The international revenues of these large companies have actually been boosted in pound terms as the currency has weakened, supporting valuations on the UK stock market. The FTSE 250, which has a greater share of smaller UK-focused companies, has significantly underperformed the FTSE 100 since Brexit, by around nine percentage points. This suggests that financial markets have taken a dim view of the economic outlook for the UK as a result of the Brexit vote. Finally, 10-year UK bond yields have fallen to their all-time lowest levels (0.86%), an indication that markets expect lower growth in the UK.

Second, the impact on Europe has been more muted. The euro is down since the referendum and the stock market has fallen around 5%. The Brexit vote has raised uncertainty around Europe’s economy as well as the EU project in general. A slowing UK economy is likely to negatively impact Europe as import demand from the UK weakens. But markets also expect a monetary response in Europe and yields have fallen dramatically across the continent.

Selected exchange rates after Brexit

(% change in local currencies against USD)

Selected exchange rates after Brexit

Sources: Bloomberg and QNB Economics

 Third, other major advanced economies have been relatively unaffected by the Brexit vote. The exchange rates of the Japanese Yen and US dollar have both appreciated. These economies were the principal locations for safe haven flows as uncertainty rose in the aftermath of the Brexit vote. The referendum result has also prompted a dramatic turnaround in market expectations for US monetary policy. On the eve of the vote, the market-implied probability of at least one Fed rate hike by the end of this year was 50%. However, in the aftermath of the vote, markets briefly priced a Fed cut as marginally more likely than a hike and now see the probability of at least one Fed rate hike this year as only 12%. This suggests that the potential dislocations caused by the Brexit vote could pose serious downside risks for the world economy. As a result, US 10-year yields fell by 30 bps by 1 July to the lowest level since the European debt crisis in 2012. This turnaround in the expectations of US monetary policy has probably helped keep a lid on the appreciation of the US dollar and should lend support to the global economy.

Finally, the post-Brexit adjustments in global financial markets suggest mixed impacts on EMs. Increased uncertainty and heightened risk sentiment is having a negative impact on some EMs. However, easier global monetary policy could counteract some of the negative impacts. The worst hit currencies of the major EMs in the week after the Brexit vote were the Turkish Lira, the Chinese Renminbi and the South African Rand. The Brazilian real actually rose 3.1% by 1 July, but this was mainly due to an improving domestic outlook. Meanwhile, the MSCI EM index was 0.5% up from 23 June to 1 July and JP Morgan’s EM bond index was up 1.9%.

In summary, the initial financial market response to Brexit suggests that the negative impacts will mostly be confined to the UK, with some spillover to the rest of Europe and certain EMs. Heightened risk perceptions and uncertainty have led to a global shift towards easier monetary policy, which should help cushion the negative effects of the Brexit referendum.


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