The United Kingdom (UK) vote to leave the European Union (EU) had a significant short term market impact, and will likely have longer term political and economic consequences as well.
Immediately preceding the June 24th vote, markets appeared to be discounting a “Remain” vote as currencies and stock markets rose, and media pundits discussed the “bookie gap” purportedly showing heavy betting by “smart money” on a Remain outcome. Market watchers pointed to the markets action and predicted confidently that the United Kingdom would choose to remain in the EU. They were wrong.
As results arrived overnight showing that voters had chosen to leave, surprised politicians, investors, and media pundits reacted strongly (one might say hyperventilated). Prime Minister David Cameron resigned and the UK currency, the pound, fell to the lowest level versus the US dollar since 1985. News outlets reported expectations of economic damage to the UK, the European Union, and global growth more generally. Financial markets, especially currencies and banking shares, convulsed with Gold running nearly $100 per ounce higher, while bank shares fell. At one point early Friday morning, Barclays was down 17%, RBS dropped 17%, Lloyds fell 19% and Germany’s Deutsche Bank and Switzerland’s HSBC tumbled 14% and 9% respectively. In the most recent week markets recovered, in some cases posting the strongest week of 2016, and most measures of financial stress improved.
Our opinion on the recent Sturm und Drang is that the short term affect is likely more muted than was initially thought. However, we don’t believe we’ll know the extent of the long term affect for some time as it will take months for the United Kingdom to first reform political leadership including a new Prime Minister, and then to negotiate a new deal with the EU. This deal will then need to be ratified by all remaining 27 EU members. Some points:
• Short term uncertainty will be somewhat negative for both the UK and the EU
• UK pound weakness will likely be simulative to British economic activity
• Much of the geopolitical effects will depend on the tone of the UK/EU negotiations
• There is little incentive for the EU to make it easy on the UK as this might encourage other member countries to hold their own membership referendums
• The EU has not had a strong economy recently and is known to have a heavy debt burden
• Removing a relatively strong economy like the UK from this structure is likely to weaken it
• Therefore, the long term possibilities of increasing German control of Europe, and of the ultimate fragmentation of the European Union are increased
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