Since the Brexit referendum, analysts have been busy assessing the impact on economic and financial markets from the U.K.’s shock vote to leave the European Union. Their conclusion? Eurozone and U.K. economic growth will be hard hit in the next few years — and that will force central banks to take action.
Under heavy pressure to react to the June 23 vote, both the Bank of England and European Central Bank expected to provide more stimulus, and analysts believe they’ll deliver.
“After the Brexit shock, Europe is one step closer to a persistent 1% growth, 1% core-inflation economy,” analysts at Bank of America Merrill Lynch said in a note Monday.
The region can’t sustain those levels in the long run, either politically or socially, given its high unemployment rate and poor productivity development, they added.
“This is a very unstable equilibrium, only sustainable because of the ECB backing. But we expect it to destabilize once [quantitative easing] is gone, absent any further policy innovations,” the analysts said.
“And we remain skeptical about those innovations.”
That doesn’t mean, however, that the ECB won’t introduce more easing to the eurozone economy, to soften the Brexit blow. The B. of A. analysts expect the central bank to bring forward its stimulus actions, and they see policy makers using their July 21 meeting to deliver “serious” hints of hard moves in September.
Investors may get a hint of what’s coming when ECB President Mario Draghi speaks in Frankfurt on Wednesday at 9 a.m. Central European Time, or 3 a.m. Eastern Time.
Further easing could come in the form of extending the ECB’s bond-buying program beyond March 2017. Governor Mario Draghi and team could also abandon the capital key, which determines how many bonds from each country it can buy under the QE program, they said.
Other investment banks — including Citigroup, J.P. Morgan and Deutsche Bank — agree that the ECB is likely to strike a more dovish tone at its July meeting, prompted by the Brexit vote.
Markets have already reacted strongly to the referendum outcome. The pound
GBPUSD, -0.2860% slid more than 10% against the dollar, while the Stoxx Europe 600 index
SXXP, -0.74% posted its biggest loss since 2008.
“If market pressures build, a frontloading of QE is possible. If spreads widen in a disorderly way, the ECB could choose to temporarily deviate from the QE capital key,” analysts at Deutsche Bank said in a note.
“There are non-negligible political costs with this, and other differential policy options may be easier,” they added. One option could be to offer another round of cheap loans to banks via targeted longer-term refinancing operations, or TLTROs.
Most investment banks don’t expect the ECB to further cut interest rates, after it yanked them lower at its March meeting.
Brexit triggers series of GDP downgrades
For the Bank of England, however, a rate cut almost seems inevitable, analysts said. Concerns over the future of the U.K. economy post-Brexit have been a key topic since the referendum was announced in February. Since the ballot in June, GDP forecasts for the country have been consistently slashed.
B. of A. said it now expects three quarters of recession in the U.K., starting in the third quarter of 2016. It cut its GDP forecasts to growth of 1.4% in 2016 and 0.2% in 2017, down from previous forecasts of 2.5% for both. The bank also revised its 2017 eurozone GDP forecast down to 1.1%, from 1.6%.
Citigroup sees U.K. growth of 1.3% for 2016 and 0.9% for 2017, down from 1.7% and 2.1% respectively, while J.P. Morgan forecasts a slowdown in 2017 to 0.6%, from 1.1%.
