RaboResearch - Economic Research

Brexit vote lowers economic growth in the eurozone

Economic Report

  • We expect that UK’s vote to leave the EU will negatively affect economic growth in the eurozone
  • We believe that the impact in 2016 is rather small, but we lower our growth forecast for 2017 by ¼% to 1¼%
  • For the Netherlands we also lower our forecast for 2017 by ¼% to 1¾%. The potential downward risks for the Netherlands are larger though, mainly because of the strong trade ties to the UK

We expect that Britain’s vote to leave the EU will negatively affect economic growth in the eurozone. The impact possibly runs via trade links, confidence channels, monetary policy shocks and wealth effects due to declining asset prices. It is difficult to pin down exactly by how much economic growth will falter. This depends, amongst other things, on what households, businesses and investors in both the EU and the UK expect regarding post-Brexit (trade) relations between the UK and Europe. To be clear, in this piece we do not look at how an actual departure of the UK from the EU will affect economic growth in the eurozone and its member states. We expect this will not happen before 2019. Yet we specifically assess how the vote in favour of a Brexit itself alters economic growth in the eurozone and the Netherlands in 2016 and 2017.

Brexit vote subtracts ¼% from eurozone economic growth

After reviewing all the channels we maintain our GDP growth forecast for the eurozone for 2016 at 1½%, but we lower it for 2017 by ¼% to 1¼%. Also for the Netherlands we lower our GDP growth forecast by ¼%, to 1¾% in 2017. That said, we believe the Dutch economy could be affected more strongly than most other eurozone countries due to strong trade ties: Britain is one of the most important trading partners of the Netherlands and compared to other eurozone countries, the Dutch economy depends substantially on exports (box 1). Accordingly, in our next forecasting round due in September we will review if a further reduction in the economic growth outlook for the Netherlands in 2017 is warranted. We have also downwardly adjusted our growth forecast for the Netherlands in 2016, from 2% to 1¾%. However, this downward adjustment has been motivated by other reasons than the Brexit vote. Mostly because of an extreme drop in gas production in May. 

Uncertainty could depress investment and household consumption

Official negotiations over future trade relations between the UK and Europe are currently expected to start early 2017 and drag on until early 2019. Lingering uncertainty over the outcome will likely hit business and consumer confidence, depressing eurozone investments and household consumption. At the same time, the uncertainty might induce existing businesses to move from the UK to mainland Europe and new businesses to settle in eurozone member states instead of the UK. Eurozone investment and thus economic growth would benefit. However, we believe most existing businesses will pursue a wait-and-see approach, before deciding whether to leave the UK. Accordingly, for this and next year, the negative growth impact of increased uncertainty is expected to outweigh the potential positive effects of redirected investments.

Figure 1: Composite PMI is rather stable
Figure 1: Composite PMI is rather stableSource: Macrobond

Confidence indicators from after the Brexit referendum are scarce, yet so far the overall impact on euro area sentiment seems rather contained. Consumer confidence in the euro area has only softened somewhat, while producer confidence has slightly improved. Meanwhile, the eurozone Composite Purchasing Manager’s Index (PMI) only marginally worsened in July (figure 1), with the manufacturing sector most to blame. July’s composite PMI is not known yet for all counties, but there appears to exist some divergence between member states. With the figure improving in Germany and France and worsening in Italy and Spain. 

Lower economic growth in the UK leads to lower export growth in the eurozone

We expect that the effect on eurozone export growth will be negative, yet contained. Export growth can be affected via lower economic growth in the UK and via exchange rate movements. We have lowered our economic growth forecast for the UK by 0.4%-point in 2016 and almost 1%- point in 2017. This will expectedly shave of some percentage points of eurozone export growth.

Figure 2: Small appreciation of effective exchange rate
Figure 2: Small appreciation of effective exchange rateSource: Macrobond

The effective exchange rate of the euro has only slightly appreciated since the Brexit vote (figure 2). The euro appreciated sharply against the pound, but depreciated against the dollar. Looking forward, we expect that the Brexit-vote related euro appreciation against the pound will have a longer lasting effect on the effective exchange rate of the euro in 2017 than recent and yet to come euro depreciation against the dollar. As such, the referendum outcome likely also has a small negative effect on exports via exchange rate movements.

Drop in interest rates: economic growth versus financial stability risks

Figure 3: Eurozone government bond yields are lower than pre-referendum
Figure 3: Eurozone government bond yields are lower than pre-referendumSource: Macrobond

After the referendum outcome, bond yields of core member states fell quickly in a flight to safety, while peripheral yields followed a few days later (figure 3). Moreover, yield curves have flattened further. Against the background of rising uncertainty and the weakening economic outlook, the ECB will likely prolong its loose monetary stance or even ease it further. President Draghi emphasised in his July press conference that additional monetary action was not warranted yet, but that the Governing Council will re-evaluate all new data evidence before their next meeting on 8 September. Given the number of downside risks that were mentioned, we believe that action in the September meeting (i.e. a 10 bps cut in the deposit rate from -0.40% to -0.50%) remains a realistic possibility. In any case, the upcoming meeting promises to be a very data-dependent one, with any potential new measures announced closely related to the way financial and economic conditions will evolve in the coming months. That said, additional measures will likely have only marginal economic effects, while they further increase risks to financial stability.

Stock indices have recovered from initial drop, yet ongoing volatility would hurt economy

Figure 4: Bank shares suffer most from Brexit vote
Figure 4: Bank shares suffer most from Brexit voteSource: Macrobond

In the immediate aftermath of the Brexit-vote, stock indices across the eurozone plummeted and closed more than 7% lower (figure 4). Especially bank stocks were hit severely because of concerns about financial stability. Most stocks, except that of banks, have regained their value by now in anticipation of more ECB interventions. Nonetheless, we expect that volatility in eurozone stocks is likely to stay high in the coming period as negotiations will continue to dominate newspaper headlines. If volatility indeed persists, this may hurt economic confidence and, consequentially, economic growth.

Box 1: Negative economic effects Brexit vote more strongly felt in the Netherlands

The negative economic effects of the Brexit vote could be more strongly felt in the Netherlands than in other Eurozone countries, mainly due to strong trade ties with the UK. Lower growth in the UK and the appreciation of the euro vis-à-vis the pound sterling will have a stronger negative effect on Dutch trade than in most other eurozone countries. The fact that Dutch GDP is more reliant on exports than most eurozone countries only magnifies the negative trade effects. The resulting lower export growth will expectedly result in lower Dutch economic growth in 2017.              

In addition, the declining interest rates after the referendum could also have a negative effect on Dutch economic growth. The Netherlands has the highest ratio of pension assets to GDP in the world. Lower interest returns weigh on pension coverage ratios, which are not allowed to drop below regulatory thresholds. This puts increasing pressure on pension funds to lower pension payments or increase pension contributions for the working population. Both will reduce disposable income and increase uncertainty for households, which negatively affects consumption.

Maartje Wijffelaars
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 2257 0569
Martijn Badir
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
Daniel van Schoot
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO

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