From Westpac:
• Last Thursday, the UK voted in favour of exiting the European Union.
• 52% of the population voted in favour of the decision, on a turnout of around 72%.
• The decision was against market expectations, bringing about a savage market response.
• Subsequent to the result being announced, Prime Minister David Cameron resigned, effective by October. The opposition is also in disarray, with ten or so members of the shadow cabinet having quit or been fired.
• Until a new Prime Minister takes office, the next step in the Brexit process seemingly will not take place.
• That next step is most likely to be Article 50 of the Lisbon Treaty being invoked, ushering in a two-year consultative period between the UK and European Union.
• Note the UK will also have to enter into separate negotiations with a further 60 non-EU nations, whose trade terms are dictated by European Union agreements.
• Of particular concern for markets is the potential for the ‘Brexit’ decision to trigger similar reviews of EU membership across other member countries and the unity of the UK itself, with Scotland and Northern Ireland voting in favour of the UK remaining in the EU.
• The above highlights that we are at the beginning of a long process full of uncertainty and tension. • With the end-point of this process unknown, we are unable to estimate the full impact of Thursday’s decision. IMF estimates however highlight it will be substantial: a shock to the level of GDP of between 1.4ppts and 5.6ppts by 2019. Note, UK growth to March 2016 was 2.1%yr.
• Of course, all of this is not happening in a vacuum. The implications for the rest of the world have, and will continue to be, significant. • Market pricing for the FOMC has reversed, with a near 20% probability of a cut now priced in by November. A rate hike is not fully priced in until June 2018.
• Policy intervention by the Bank of Japan also seems likely, with USD/JPY nearing the ¥100 mark.
• Elsewhere in emerging Asia, policy makers will be paying close attention, not only for potential implications for their real economies, but also in case funding dislocations become apparent. Europe has long been a key provider of direct and portfolio funding for the region.
• For Australia, the RBA stands ready to act to provide liquidity (if needed), while the Australia dollar has fallen with the shift in risk sentiment.
• As such, while these events make Westpac expect a rate cut in August with near certainty, we don’t believe they will spook the Bank into an ‘emergency’ cut in July. We instead believe the RBA will keep their powder dry as events unfold and be guided by the Q2 CPI print due to be released on July 27th.
