The impact of BREXIT will be far beyond the UK and the EU…
The UK with an annual GDP of nearly $4 trillion accounts for a little over 5% of global GDP. It surely does not have the impact that the US or China could have on global demand. But, UK cannot be written away as its impact on global markets can be much larger than the 5% GDP share that it enjoys.
Contagion is the fear…
The fact of the matter is that the BREXIT vote actually complicates matters substantially. Remember, Scotland has already voted to remain in the EU and therefore a vote on Scottish secession should happen sooner rather than later. If Scotland secedes, then Spain cannot be far behind. The province of Catalonia has been trying hard to secede from Spain, albeit with little success. The BREXIT vote as well as the rise in popularity of the UKIP will give renewed boost to the idea of secession. The aftermath of BREXIT will result in spreads of vulnerable economies like Ireland, Italy, Spain and Portugal widening. This could create a situation like Greece where the PIGS economies may see little merit in staying on in the EU. Germany will then have a real tough time holding the EU together under its leadership.
Dollar could strengthen?
On the day of the BREXIT vote, the UK£ dropped by almost 10% to a 31-year low versus the US$. This could just be the beginning. Today the sharp shift from Pound to dollar and Yen was clearly visible. With the UK£ and the Euro coming under attack due to a likely economic slowdown, there will be a sense of urgency to shift out of these currencies into more safe-haven currencies. As we have seen on previous occasions, the US Treasuries may emerge as the preferred asset class once again. Especially, if the shift to risk-off investing gathers steam! A slowdown in EU and UK will mean weak demand for oil and industrial commodities and both may lose their gains. Gold, on the other hand, may increasingly attract safe-haven demand and also emerge as an alternate currency. Gold could be an asset to hold value among asset classes.
Back to good-old dovish policies!
For the global central banks, who have been trying to think hawkish, it may be back to their dovish policy ways. There was a spurt in dovishness in the aftermath of the sub-prime crisis in 2008. Subsequently, the European crisis in 2011 led to the second round of cheap money policies, especially by the ECB. With the UK and the EU threatening to slow down, the Fed will surely put off its rate hike plans to a future date. They may also be inclined to adopt a more accommodative and dovish approach to monetary policy. That means that global economic recovery will still be some time away! ©