Britain's vote on Thursday to exit the EU will trigger political uncertainty within Europe which in turn may lead to a severe global market correction, according to Hermes' CEO Saker Nusseibeh.
Financial markets across the world plunged on Friday morning following the result of the referendum and economists and industry watchers are forecasting a period of extended uncertainty. 'In any case,' said Nusseibeh, 'we know that we are now in an even more prolonged super low interest rate environment outside of the UK, with the US likely to delay its decision to raise interest rates even further out.'
Nusseibeh said Hermes was watching market moves very carefully to assess the degree of contagion, if any, to global markets. 'Besides a sharp sell-off in risk and in sterling, as well as a recession in the UK (which is expected) our fear is that this may trigger political uncertainty within Europe which in turn may lead to a severe global market correction.'
Hermes' chief economist Neil Williams noted that eyebrows are being raised across the City of London. 'The UK’s vote to leave provides a massive "curve ball' for financial markets, which now need time to assess the policy path that a likely, new political line-up will eventually choose to go down. All of this will take time.
Can of worms
Williams said equities and the pound may remain vulnerable given the likely hit to UK growth, and risk now of weaker ties with the country's main trading partner. He also expects 'a diluted relationship' with the US and other third parties that use the UK to access the single European market.
'The UK economy will of course "survive", given its entrepreneurial flair, increasing focus on non-EU trade, and likely policy accommodation by the Bank of England and UK Treasury. However, getting to the next stage looks a long, drawn-out "can of worms", leaving considerable uncertainty for UK assets and markets. The extent of this damage now rests on the manner of the exit.'
Williams expects the mark-down on assets will be greatest in the case of a ‘hard exit’ - entailing an acrimonious departure, lower trade, lower migration, and recession - than the more probable ‘softer’ version. 'But, even a "soft exit" to a Norway or Switzerland-style associate membership will probably need several years just to end up close to "square one". Greenland’s soft exit in 1985 had taken three years. We, larger and 43 years entwined in the European project, will need even longer.'
Spillover to Europe
The spillover of exit-risk onto the doorsteps of other European governments may mean little sympathy from them in securing a ‘no strings’ UK deal, Williams noted. 'With the exit "trapdoor" opening today, voters in EU countries facing big elections - Germany, France, Spain and potentially Italy and the Netherlands - may wish to approach it. In the eyes of markets, this could erode the safe-haven status of the EU itself, and (together with the ECB’s QE) support the US dollar. If sustained, this offers an additional brake for the US Federal Reserve to "peak out" early on raising US rates.'
The vote in favour of a Brexit also risks tarnishing the UK’s vital financial services sector with all the macro, passporting and regulation risks that Brexit threatens, Williams added. 'The City of London has more than most to lose from Brexit, given its status as a global centre, gateway to the EU, and dominant force in clearing European financial markets. Given its strong starting point and comparative advantage, Brexit may not prove a complete "disaster" for London - but it’s a risk we did not need.
'The challenge now facing the UK is to try to remain at the European negotiating table to secure the best possible trade and regulatory deals for the services sector as a whole. Services represent as much as 80% of the UK’s gross value added.'
Other hurdles
Williams noted that the UK's macro policy may also be disrupted by the Brexit vote. 'With his GDP and tax-revenue plans likely to be revised down, the (next) Chancellor may have to forego returning to budget surplus by 2019/20.
The Bank of England will of course be watching to make sure a weaker pound doesn’t pump inflation down the line. But, we doubt its hand will be forced to raise Bank rate, given Brexit’s feared hit to growth. Conversely, it may be loathe to cut rates if sterling is weakening.'
