Global markets brace for Brexit slump
THE global economy faces months – if not years – of slower growth as Britain’s stunning decision to abandon the European Union threw financial markets into a tailspin and darkened the outlook for corporate and consumer spending.
Though the damage is likely to be concentrated on the other side of the Atlantic Ocean, experts said the repercussions would ripple across the world and into the United States. The domino effect was on full display on Friday as the Dow Jones Industrial Average plummeted more than 600 points in one of the most harrowing days of trading this year. The drop was even more dramatic in Europe and Asia, where major stock indexes sank 7 per cent or more.
The vote escalated the risk that the global economy would not just stall, but actually slip into recession. Recurring crises over government debt in Europe, the bumpy slowdown in China and the collapse in commodity prices have already battered prospects for global growth. International policymakers have long warned that the sluggish recovery from the Great Recession has left the world economy more vulnerable to another downturn.
Britain’s exit from the EU – popularly known as Brexit – could prove to be the final straw, experts said.
“We think the time has come to consider that a financial market crash today may push a world economy teetering on the verge of a contraction over the edge,” said Carl Weinberg, chief economist at High Frequency Economics.
The freefall in financial markets was a testament to the massive uncertainty surrounding the logistics of a separation. Economists said it would make businesses and households nervous about spending and could complicate trade between British companies and their partners in Europe and elsewhere. Prolonged volatility could stress European banks, and fluctuations in markets could test struggling countries such as Italy and Greece.
Britain will spend at least two years negotiating the terms of its departure from the 28member alliance that has dictated the economic and political order in Europe for more than four decades. Britain must elect new leadership, strike new trade deals and craft a dizzying array of new regulations about issues such as immigration and investment.
Brexit supporters argued that leaving would boost the country’s economy in the long run, allowing businesses and entrepreneurs to innovate and grow free from the red tape imposed by EU bureaucrats in Brussels. But many analysts say that optimistic scenario is unlikely, at least for the foreseeable future. On Friday, Moody’s Investors Service cut its forecast for Britain’s growth this year by half a percentage point and downgraded its debt rating, raising borrowing costs for a country with one of the largest budget deficits among advanced economies.
“Moody’s expects heightened uncertainty, diminished confidence and lower spending and investment to result in weaker growth,” the company said.
Economic officials around the world had discussed the possibility of Brexit in dire tones before the vote. IMF Managing Director Christine Lagarde called it “negative on all fronts”. The Bank of England dubbed it “the biggest domestic risk to financial stability”. Federal Reserve Chair Janet Yellen carefully warned it would have “significant economic repercussions”.
According to an analysis by Morgan Stanley, Brexit will shave between 0.3 to 0.6 per cent from US economic growth next year, draining some of the recovery’s momentum. The forecast for the world economy is more pessimistic. The worstcase scenario is that the rate of expansion falls below 3 per cent in 2017, “re-entering the danger zone for a global recession”, the report said.
That would create a dilemma for the world’s central bankers, often viewed as the stewards of their economies. Officials have been flooding the financial system with easy money for years in hopes of jumpstarting growth. Japan, the European Central Bank and some European countries have institutednegativeinterestrates, while the Fed has ballooned its balance sheet by trillions of dollars.
Now, faced with yet another blow, it is unclear how much more central banks can do.
Some analysts have began speculating that the Fed will need to cut its influential interest rate, just six months after raising it for the first time since the recession amid hopes that the US recovery had solidified. At the very least, economists said, the Fed is likely to remain on hold when it meets again next month.
“Instability in Europe is going to have worldwide repercussions, especially at a time when growth around the world is so low,” Cornell University economist Eswar Prasad said.
Investors were clearly shocked by the results from Britain’s referendum on Thursday as vote tallies began trickling in overnight. Public opinion polls had been giving a slight edge to the campaign to remain in the EU, but early on Friday morning it became apparent that the polls had been wrong – and traders started scrambling for the exits.
The sell-off began in Asia, where Japan’s Nikkei index briefly halted trading in futures and ended the day down 8 per cent. The British pound nosedived to levels not seen since 1985, at one point falling about 10 per cent to $1.32. London’s FTSE 100 dropped nearly 9 per cent before clawing back. Bank stocks were hit particularly hard, with Barclays down a whopping 35 per cent at its nadir.
That forced international policymakers to shift from issuing warnings to reassuring anxious investors of the strength of the global financial system. Regulators have instituted new safeguards since the crisis in 2008, including requiring banks to hold more capital and regularly running operational “stress tests”.
In a joint statement, the Group of Seven finance ministers and central bankers said they stood ready to provide liquidity and pledged to work together to ensure that mar- kets continued smoothly.
“We affirm our assessment that the UK economy and financial sector remain resilient and are confident that the UK authorities are wellpositioned to address the consequences of the referendum outcome,” they said.
Friday’s volatility recalled similar bouts of turbulence over the past two years that were largely driven by fears that China’s economy was stumbling. Investors fled into safe-haven assets and sent the US dollar skyrocketing. The strong currency made US exports more expensive, dragging down domestic growth.
That dynamic was repeated on Friday as the dollar jumped more than 2 per cent against a basket of other currencies and traders sought out the relative safety of gold and US government bonds. Gold prices hit a two-year high, while the demand for 10-year Treasury notes pushed yields down to 1.58 per cent, a level not seen since 2012. (Yields move in the opposite direction of prices.)
One bright spot could be mortgage rates, which are closely tied to long-term yields. The cost of a 30-year home loan has fallen over the past year and could go even lower - at least, for those who can qualify, experts said.
“We don’t know whether banks will have an appetite for lending to home buyers even though mortgages likely will get even cheaper,” said Nela Richardson, chief economist at Redfin.
Britain’s decisions have an outsize influence on the global landscape. London is the financial centre of Europe and home to some of the world’s biggest banks. Many corporations view Britain as the gateway to the continent’s common market, with exports accounting for roughly a quarter of the country’s economic output. to function