24 Jun 2016 08:58

British plunge themselves and the EU into the unknown

The world has been plunged into unknown – mainly political – territory after voters in the United Kingdom chose by a narrow margin to say NO to continued European Union membership. Here are 24 questions and answers about the British EU referendum: the outcome, the next steps, the impact on the EU, the consequences for the UK, the effects on Sweden and the current outlook for exchange rates, interest rates and yields.

1. What was the outcome of the referendum?

Answer: Now that 368/382 districts have been counted (06:45 CET), the British people have said they want the United Kingdom to leave the European Union. The results were quite close despite a high voter turnout, increasing the risk that there will be a wide range of interpretations. The official results of the voting will be announced sometimes after 08.00 CET.

2. Who are the referendum winners and losers?

Answer: In practice, everyone is a loser to varying degrees. The recently heightening of economic, financial market and political uncertainty will persist in both the UK and the world. Major political issues are unresolved. We can expect short-term financial market volatility, which will gradually shift towards a focus on more long-term political change processes for both the EU and the UK. “Brexit” (British exit from the EU) has been, and remains, at least an 80 per cent political and at most 20 per cent economic and financial issue.      

3. What finally determined the outcome? 

Answer: In recent weeks, both the Remain and Leave campaigns have been dominated by more emotions than objective facts, which is often a characteristic feature of referendums. Meanwhile referendum outcomes usually end up close to the 50 per cent mark. In surveys, half of British voters have said immigration is the crucial EU issue; for example, 75 per cent of respondents view immigration in recent years as excessive. 

4. What is the short-term financial market reaction?

Answer: Market reactions have followed the outcome of the counting and the GBP has dropped sharply.. GBP/USD is down by as much as 8% at this point but the turbulence is dramatic. Overall the USD and the JPY have strengthened with increased uncertainty. GBP/JPY is currently down by around 12% The krona suffers as expected and USD/SEK is 4% higher and EUR/SEK 1.5% above yesterday’s close. Treasury interest rates is roughly trading 20bps lower from yesterday and stock markets in Asia suffer. Overall markets are very volatile with a sense of panic. However, would this outcome be sustained there is further to go…

The next steps – after the referendum

5. What will happen now in the United Kingdom?

Answer: Legally, the referendum outcome is only advisory and it is up to the British Parliament to decide on initiating a withdrawal process. Prime Minister David Cameron has said that such a process must begin as soon as possible. Once the UK chooses to activate the EU treaty’s exit clause, the clock starts ticking on a two-year withdrawal negotiations schedule. While two thirds of Members of Parliament want the UK to stay in the European Union, it may be political suicide to defy the referendum outcome. It cannot be ruled out that such a situation will trigger unexpected constitutional challenges.   

6. …and what will the EU do?

Answer: Next week’s EU summit (June 28-29) is expected to discuss the UK referendum outcome and what steps to take next. Like many others, EU leaders are probably shocked by the British referendum outcome. Summit participants also need to discuss how the EU should pursue new strategies, a process that will be time-consuming. 

7. Does the world continue to face uncertainties?

Answer: The British referendum has unfortunately been only one of numerous sources of concern for the world economy. Global growth is sluggish and vulnerable to reversals. The US presidential election and Federal Reserve interest rate hikes, China’s economic rebalancing and debt situation and heightened geopolitical uncertainty have been overshadowed by Brexit.

Consequences in the EU

8. How have EU capitals reacted to the outcome?

Answer: So far, EU heads of state and government have reacted with silence (and are presumably in a state of shock). The Brexit issue has already required a great deal of political energy in the EU. Taking various steps now that create disunity would risk both a political and economic blowback at a delicate stage of EU developments. Looking ahead, it is in the interest of both the British and the EU to take pragmatic steps in order to prevent the risk of new reversals.  

9. How will the outcome affect EU prospects?

Answer: Its economic impact will be negative but probably limited. Uncertainty has increased, and global challenges persist − including a major risk of continued high propensity to save, low investment appetite and consequent sluggish growth and low real interest rates. 

10. How will it affect ECB monetary policies?

Answer: The referendum outcome will marginally increase pressure on the European Central Bank to make its monetary policies more expansionary, but there is no indication that the ECB will now shift direction. Low inflation and low global key interest rates decrease the ECB’s manoeuvring room.

11. Will other EU countries want to try a Brexit? 

Answer: This will be decided by Brussels along with Germany and France. An alarm bell has sounded. The EU is under greater pressure to give member countries more self-determination. Meanwhile the refugee crisis remains unresolved, while populist headwinds are strong. Expanded defence and security policy cooperation may provide a path towards reducing the risk that other countries will want to test their own “exit strategy”. 

12. Making choices: Where is the EU actually headed?

Answer: The Brexit referendum has thrown a spotlight on what future strategy the EU must choose. All this is happening while the EU is struggling with various other major challenges, such as economic growth, the euro, the refugee crisis and the security policy situation. The choice is between greater integration – leading to more EU and euro – and more national self-determination. Signals from the most important EU capitals indicate a welcome rethinking. Both German Chancellor Angela Merkel and French President François Hollande will face their voters in 2017; right-wing populist movements like Alternative für Deutschland and the Front National must be faced down at national level before these elections.

Consequences in the UK

13. Can Prime Minister David Cameron stay in office?

Answer: The whole Brexit process has been controversial, both nationally and globally: a risky project launched under domestic political pressure, with potential historical and global implications. Cameron has already said he will step down before the next election (in 2020 at the latest). The outcome of the referendum will speed up Cameron’s resignation as Tory leader and PM.

14. What will happen with Scottish independence?

Answer: After the 2014 referendum in Scotland, where 55 per cent of Scottish voters rejected independence, the risk of the UK falling apart is now increasing. In the June 23 EU referendum, 62 per cent of Scottish voters chose the Remain alternative and 38 per cent chose Leave.

15. Is there a big risk of an early UK general election?

Answer: The referendum has split the country geographically and politically. Although an early election is probably not in the Labour Party’s interests due to its weak position, frustration and disunity among the Tories may increase the risk of such an election.  

16. How will the outcome affect the British economy?

Answer: Uncertainty about the referendum has created a “wait and see” situation. Downside risks will now increase, while an expected short-term upturn will not occur. Due to uncertainty, the UK may see negative growth in the next few quarters and thus technically experience a recession.

17. What about Bank of England monetary policy?

Answer: Risks to economic growth have increased and there are still major international challenges. Inflation is also low. Our forecast is that despite a weaker pound, the British central bank will act by cutting its key interest rate or expanding its stimulative bond purchases. Moreover, it is not unlikely it could intervene in the currency if the GBP continues to depreciate. 

Consequences in Sweden

18. Will the outcome affect Sweden’s growth outlook?

Answer: Right now the Swedish economy is being controlled by domestic forces: construction, public sector consumption and investments (the refugee crisis) and private consumption. Greater uncertainty will result in a marginally worse outlook. Looking ahead, increased global worries may hurt Swedish exporters, especially manufacturers of investment goods.

19. Will the Riksbank change interest rate strategy?

Answer: The main scenario of Sweden’s Riksbank seems to have been that the UK would vote Remain. Conditions will thus change to some extent. There will also be increased pressure on the ECB to do more. Our main scenario is that the Riksbank will reverse its negative key rate in 2017, but there is an increased probability that its first rate hike will be delayed. 

20. How big is the risk of a “Swexit”?

Answer: Swedish political leaders – except for the Left Party – are unlikely to initiate a process of renegotiating Sweden’s relationship with the EU. A fresh Sifo opinion survey shows that 70 per cent of Swedes support the EU – but they dislike the euro. 

Consequences in global financial markets

21. How will the outcome affect the Swedish krona?

Answer: In the short term, global uncertainty and depressed risk appetite are expected to result in a continued squeeze on the krona (the Riksbank will be forced to continue its loose monetary policies). Looking ahead, greater uncertainty about the euro may trigger capital flows into Sweden and thus strengthen the krona.

22. How will the outcome affect the British pound?

Answer: The pound has already depreciated sharply. Early in the referendum week, growing hopes of a Remain outcome led to a recovery from most of the pound’s previous slide. Now that the UK is on its way towards leaving the EU, we can expect continued weakness for the pound. The UK is suffering from both budget and current account deficits, making it dependent on foreign capital inflows. Given the uncertainty resulting from the referendum outcome, the appetite of foreign investors for pound-denominated assets is likely to be limited until the effects of British withdrawal from the EU become clearer. We believe that the GBP/SEK exchange rate may fall to 11.20 before recovering somewhat.

23. How will it affect the rest of the FX market?

Answer: Uncertainty ahead of the referendum has already had a major impact on various currencies, although signs this past week that the Remain side had pulled ahead of Leave partly reversed their movements. Looking ahead, the main currencies that will benefit are classical safe havens like the Japanese yen, Swiss franc and US dollar. Until we have a clearer picture of what the referendum outcome will mean in political, economic and financial market terms, we can expect the latter currencies to remain strong. However, we believe that at today’s exchange rates they are overvalued and should weaken in the future, assuming that the world economy is not affected extremely negatively by the outcome. 

24. How will interest rates and yields be affected?

Answer: Although interest rates and bond yields have been squeezed for a while as a consequence of Brexit worries, we are already seeing how US yields are falling sharply. When the Swedish money market reopens on Monday, June 27, this will also impact Swedish yields (about 10 basis points downward). We must probably expect market rates and yields to remain depressed this summer, until we see clearer signs of what consequences and contagious effects Brexit will have. However, there is a risk that British yields may climb in the future if demand from (mainly foreign) investors should fall dramatically.