On 23 June the British people voted to leave the EU. The long-term macroeconomic fallout of the vote and its impact on the EU as a whole is difficult to assess, while the country-specific effects on the remaining 27 member states depend largely on the intensity of their respective economic ties with the UK.
The repercussions of Brexit for European exporters and investors with exposure to the UK could range from minimal to immense, depending on the follow-up agreements negotiated between the EU and the UK. A number of models are currently under scrutiny, among which the Norwegian model (which involves membership of the European Economic Area) and the Swiss model (which centres on a number of bilateral agreements) are the most economically beneficial, as they come close to full membership of the EU’s single market. Irrespective of the final legal framework, however, we believe that the long-term economic impact of Brexit on the UK itself will be significant and negative, while demand and supply shocks to the rest of the EU are likely to be milder.
Short-term Transmission Channels
In the short to medium term the ripple effects of Brexit will affect the EU via three main channels: politics, trade and currency, and confidence and expectations. To begin with, Brexit risks delivering a serious political blow to the EU and to the "EU project" by paving the way for similar membership referendums in other member states (although June’s general election in Spain suggested that this need not necessarily be the case). Indeed, with the anti-establishment Podemos party losing more than 1 million votes to the mainstream PSOE party since December’s inconclusive elections, the Spanish ballot shows that in times of high uncertainty voters may turn to mainstream parties, which they perceive to be safer. Accordingly, the Brexit vote could lead to a stabilisation of the European political landscape rather than trigger a further fragmentation.
The impact of the trade and currency channel is, in our view, limited and positive overall. Indeed, the EU only sends around 6% of its total merchandise exports to the UK. As for the euro zone, we expect the British pound to depreciate against the single currency less than it will depreciate against the other major currencies (such as the US dollar and Japanese yen), given that the euro itself is likely to be weaker as a result of the uncertainty stemming from Brexit. It follows that the drop in EU exports to the UK is likely to be more than offset by an increase in EU exports to the rest of the world (due to a cheaper single currency).
Finally, there are significant negative impacts in the form of a possible loss of confidence in the European economy and the potential for an unravelling of the project of European integration, which has ceased to be perceived as irreversible and everlasting. A prolonged period of uncertainty and market volatility (inevitable by-products of higher political uncertainty and weaker economic confidence) is set to weigh on companies’ investment decisions, and thus on real GDP growth. To reflect this, we have already downgraded Germany’s growth forecasts for this year and the next, and placed several other EU-member countries on review for a downgrade.
The Brexit vote has led to a depreciation of the euro against the dollar and other major currencies, increasing the price competitiveness of European companies. Business opportunities are likely to arise in the financial sector in particular, as the UK may lose its EU-access "passport" for banking and other financial activities. Reduced growth and ultra-low interest rates are set to hurt insurance companies: Low rates increase the discounted value of their liabilities, while lower growth will weigh on their assets’ value. The tourism and hospitality sectors could be affected by a weakened British pound. Brexit could further undermine the Transatlantic Trade and Investment Partnership (TTIP) negotiations.
Expect the euro to remain weak against the dollar and the other major currencies in the quarters ahead. Factor in lower growth when planning your business decisions for the 2016-17 period. Monitor external political and economic developments, especially related to Brexit and, to a lesser extent, Grexit. From a supply chain perspective, assume no major changes within the EU (at least in the next two years) and that the UK will continue to have access to the EU’s common market. Assume a prolonged period of market volatility, at least until the terms of the UK’s relationship with the EU are settled. From a trade perspective, be aware that both the EU and the UK are interested in maintaining close relations, thereby increasing the likelihood that both sides will eventually agree on some form of economic co-operation.