Brexit: The Economic and Financial Fallout

The Brits’ June 23 vote to take the United Kingdom out of the European Union (EU) came as a surprise. Brexit (short for “Britain–exit”) dealt a hard blow to the financial markets, which were not prepared for this possibility. In just a few minutes, once the results started to show a Brexit majority, the British pound depreciated nearly 12%, hitting a 30-year low. Nearly all of the world’s stock markets took a hit.

These movements reflect the anxiety generated by the Brits’ decision, but we must remember that, for now, nothing fundamental has changed for either the United Kingdom or Europe. The referendum’s outcome is not equivalent to an immediate Brexit. No tariff barriers have been put up, both capital and people continue to move, and Great Britain is still a full EU member. Accordingly, beyond the real impact of potential trade and financial constraints, in the near future, it is the uncertainty that could affect the economic situation. All of this will affect confidence and, in the coming weeks, it will be important to keep a close watch on consumer and business confidence indexes.

Over a longer horizon, Brexit’s impact on the British, European and global economies will depend on the outcome of the upcoming negotiations between the United Kingdom and the EU.

Like the global economy, Brexit will have economic consequences for Canada’s economy. We could assume that the major factors to watch for Canada’s economy will be:

• The level of uncertainty and erosion of financial conditions.
• A drop in commodity prices.
• An economic decline in the United Kingdom and Europe, and the effect of that on direct trade (the United Kingdom accounts for 3.5% of Canadian exports, with the rest of the EU representing 4.5%).
• The direct and indirect impact on the U.S. economy.

It is especially difficult to pinpoint what will happen to the trade agreement between Canada and the EU. Some EU countries are already expressing doubts about the agreement, and the United Kingdom’s support was essential.

Financial Scenarios

U.S. bond yields and, to a lesser extent, Canadian yields have come down a lot since the vote, and the safe-haven effect provided by the U.S. bond market should keep yields lower than anticipated. The Federal Reserve could further postpone its next key rate increase to 2017. The extended status quo already anticipated for the Bank of Canada could be prolonged further, given the even more cautious U.S. monetary policy. Weak oil prices and a strong U.S. dollar could take the loonie down against the greenback and up against European currencies. The stock markets have already taken a big hit. They could remain volatile in response to new developments. The European and British markets should take a more lasting blow, to factor in more uncertain profit outlooks and weaker potential economic growth.