David Page, Senior Economist at AXA Investment Managers: UK Referendum reaction
- We revise our UK GDP forecast for 2017 to 0.4% from 1.9%
- Expect easing in monetary policy before the year end – we estimate two 0.25% rate cuts and between £50-100 billion of QE
- Expect subdued investment and foreign direct investment to weigh on GDP
- Expect renewed pressure on households as real disposable income growth slows
The UK voted 52-48 to leave the EU, with a relatively high turnout of 72%. But regional differences were strong. Scotland and Northern Ireland voted to remain in (62-38%) and (56-44%) respectively. England and Wales both voted to leave. Within England, London and large northern cities like Manchester and Leeds voted to remain, but otherwise the decision to leave the EU was far more widespread than expected.
In the wake of the decision, Prime Minister David Cameron announced that he would stand down urging “fresh leadership” before the Party Conference in October. He said it would be down to the next Prime Minister to activate the Article 50 Treaty exit clause, which would start the formal countdown to the UK’s exit. Political uncertainty is high in the UK. Prime Minister expectations are high for a Brexit supporting leader, with Boris Johnson and Michael Gove frontrunners. Some are speculating that the Labour party may also consider a leadership challenge. More broadly, SNP’s Nicola Sturgeon has already said that the people of Scotland “see their future as part of the EU”. This suggests the revival of the Scottish referendum issue, although difficulties given the price of oil and the fact that the SNP could not afford to lose a second referendum, may delay this until towards the end of this Parliament. Northern Ireland’s vote to remain and the risks of the imposition of a hard border being reimposed between the Republic and Northern Ireland could increase tensions again there.
AXA IM outlook
The UK economic outlook is likely to be severely affected by the decision to leave the EU. The economy looks to have sagged under the uncertainty of the referendum itself, with deferral of activity. The decision to leave the EU looks likely to make much of this deferral permanent. We expect subdued investment and foreign direct investment into the UK to weigh on activity. This is likely to be supplemented by the sharp tightening in financial conditions in its wake. Moreover, an expected relative boost to the short term inflation outlook, against rising uncertainty for employment is likely to renew pressure on households. We expect UK GDP growth to slow significantly from the 1.9% we forecast in a Remain scenario. Our expectation is for quarterly growth to fall back towards zero around the middle of next year. Accordingly, we change our forecast pencilling in GDP growth of 1.5% (from 1.8%) in the UK for 2016 and 0.4% in 2017 (from 1.9%).
We continue to believe that the Bank of England will provide support for the UK economy. Governor Carney spoke this morning to reassure financial markets. He stated that the Bank stood ready to provide liquidity support in sterling and FX, if necessary. He reiterated that the commercial banking system was significantly more resilient and better capitalised than in the past. And he said the Bank would “assess economic conditions and consider other policy responses”. We have long forecast that Brexit would consider an easing in monetary policy, we estimate two successive 0.25% rate cuts and the likelihood of £50-100bn quantitative easing (QE). The May Inflation Report was more circumspect in whether it would be necessary to provide additional monetary policy stimulus. The precise scale of financial market reaction is likely to determine whether the Monetary Policy Committee begins to ease policy in the short-term (August) or November, our own view is that the latter is more likely.
Financial market reaction has been severe. Sterling has fallen sharply. It currently trades at $1.38 to the US dollar (-8% on the day), but had traded as low as $1.325 (-12%); sterling is also lower against the yen (-11%) and the euro (-6%). Equity markets have also suffered a major blow with FTSE 100 down 5.5% on the day and the more domestically oriented FTSE 250 down 8.6%. UK gilt yields also fell sharply: the yield on 10-year gilts opened 35basis points (bps) lower, but is currently trading at 1.10%, 27bps lower. Yet reaction has not been confined to the UK. Global stocks have suffered a sharp reaction to the UK’s decision. The Euro Stoxx index is down 9%, Japanese stocks closed 8% lower. Global bond yields are also sharply lower with US Treasuries down 20bps to 1.54% (35bps at worst) and German bund yields down 16bps to -0.06%.
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