The Impact of the Brexit Vote

July 12, 2016

"handsThe impact of the Brexit vote on equity markets was short-lived as investors resumed buying equities a mere 3 trading sessions after the historic vote. The FTSE 100, which consists of large multinational corporations trading in London ended the week following the vote about 5% above pre-referendum levels, and most equity markets rallied back substantially from the lows set in the trading sessions immediately following the vote.

With rates lower for longer in Europe, Japan, and the U.S., investors continue to seek relatively higher returns from equities, with U.S. dividend paying stocks a prime beneficiary of global money flows.

So far, the only enduring casualty of the Brexit vote is the pound sterling and certain British politicians.

The pound sterling plumbed new lows a week after the vote when Mark Carney, Governor of the Bank of England, spoke about slowing growth to be accompanied by interest rate cuts. The pound sterling is about 9.5% weaker against the U.S. dollar since the vote.

The vote caused upheaval in the conservative party with David Cameron’s resignation as Prime Minister and Boris Johnson’s more recent decision to quit the race for party leadership in the wake of his abandonment by former ally Michael Gove. A number of candidates for Prime Minister, including Gove, have emerged in the aftermath, and it appears that the EU has agreed to wait to start the separation process, until a new Prime Minister is elected before demanding that Article 50 be invoked.

If ultimately Britain does invoke Article 50 (the process by which Britain formally notifies the EU of its intent to leave), it is expected that it will take two years before any renegotiated trade terms will take effect. We believe the impact on Eurozone trading activity for the next two years, ahead of formal changes to the tariff structure, will be limited mostly to the currency impact and lower investor confidence. If the Euro continues to weaken against the U.S. dollar, greater exports out of the Eurozone could substantially offset lower imports into the U.K. due to pound sterling weakness. Overall, exports to the U.K. represent less than 3% of Eurozone GDP and about 13% of extra-zone exports, so greater than expected weakness in the U.K. is unlikely to seriously impact the rest of Europe.

Some economists lowered GDP growth estimates for the U.K. in 2017 by one half of one percent to reflect investor wariness about concessions that the EU might extract from Britain if Brexit is implemented. Most of the concerns relate to the importance of London’s Banking and Finance District as many global banks have chosen to establish headquarters in London for their pan-European operations, predicated on the concept of a financial passport, for cross border transactions with no questions asked due to the U.K.’s membership in the common market. It is expected that a slowdown in capital investment by banks in London would also adversely affect the London real estate market with demand for new space largely driven by financial firms.

The Brexit vote to leave the EU is a non-binding referendum, and it’s entirely possible Britain will never invoke Article 50 of the Treaty of Lisbon and instead use the referendum as an excuse to lobby for reforms to EU policies. There is precedent by other Euro states for ignoring popular mandates, with a recent notable example being Greece’s decision to abide by the terms of the EU bailout and austerity program despite its rejection by voters. Given that most politicians and members of parliament never expected Brexit to pass and had no plan for implementing an exit, we believe there is a an increased chance of a Brexit-lite, where the emphasis will be on alleviating objectionable provisions of the union rather than totally negating it. With David Cameron resigning as Prime Minister, and a replacement not expected until October 2016, Brexit appears to be on hold for the next couple of months. Before the Brexit vote, few members of Parliament were in favor of leaving which further detracts from the urgency to take action.

Elsewhere in Europe, the Brexit vote has re-energized Euro-skeptic movements in France, Italy and Spain. However, just hours after the Brexit vote, voters in Spain elected a conservative majority who quickly affirmed their intention to remain in the EU. In Italy, voters are quick to blame the EU for a decade of near zero growth amid a record influx of immigrants and refugees. Before the Brexit vote, polls indicated 48% of Italian voters favored pulling out of the EU. Given the level of support enjoyed by the “leave” contingent in many European countries, concerns about the endurance of the currency union will continue to fuel volatility in European markets for the foreseeable future.

The views expressed are those of Washington Trust Wealth Management and are subject to change based on market and other conditions. The information provided is solely for informational purposes and has been obtained from sources believed to be reliable but its accuracy is not guaranteed. All information is current as of the date of this material and is subject to change without notice. The information should not be considered a solicitation to buy or an offer to provide investment advisory or other wealth management services. The information provided does not constitute investment, legal, accounting or tax advice and it should not be relied on as such. It does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Please consult with a financial counselor, attorney or tax professional regarding your specific investment, legal or tax situation.

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