EU political contagion biggest Brexit risk - FREE

EU political contagion biggest Brexit risk - FREE

EU Political Contagion represents the greatest risk to an otherwise muted global impact from Brexit, according to Moody’s Investors Service.

Following the UK’s June 23 referendum vote to leave the EU, Moody’s expects ongoing heightened uncertainty and shock to confidence to have a significant negative impact on UK growth prospects.

The rating agency has revised these down “driven by a precipitous fall in investment”, to 1.5% in 2016 and 1.2% in 2017, from 1.8% and 2.1% respectively.

“At the same time, the fall in the sterling will mitigate some of the negative effect in the short term by providing a boost to exports. A material correction in asset prices, house price downturn, or a large decline in consumption represent downside risks to the forecast, and if they were to materialize would prompt us to revise the baseline,” said the report from Moody’s.

Downside risks to UK growth are large, according to Moody’s, and stem from the impact of prolonged negotiations and uncertainty on consumer and investor confidence, and from the eventual outcome of trade negotiations.

“Downside risks to global growth stem not from the possibility of a recession in the UK, but from the possibility that developments in the UK may give rise to increased political risk elsewhere in the EU,” said Moody’s.

“Its size makes the EU systemically important to the world economy and the US. The materialization of negative risks in the EU would, therefore, have significant consequences for global trade and growth,” said the rating agency’s paper.

Absent political contagion, Moody’s expects limited spill over to EU growth overall, citing “asymmetric” EU-UK trade linkage, with UK exposures to the EU much larger than EU exposures to the UK.

“For example, while 48% of UK exports go to the EU, only 7% of EU exports are destined for the UK.

Therefore, assuming manageable global financial markets turbulence, there will be limited spillovers to the large EU economies,” said Moody’s.

“Reflecting country-specific developments combined with limited spillovers from Brexit, we have lowered our growth forecasts for Germany, France, Italy and Spain by between 0.0% and 0.4%. Overall, we have lowered our euro area growth expectations to 1.5% for 2016 and 1.3% for 2017, from 1.7% and 1.6% previously,” noted the rating agency.

Similarly, the rater expects impact on US growth to be minimal, with exports to the UK accounting for only 4% of US exports and 0.4% of US GDP, so Moody’s has kept its estimates for US real GDP growth at 2% for 2016 and 2.3% for 2017.

Global downside risk stems from the risk of EU political contagion, the rating agency said.

“There are significant downside risks to the baseline forecasts, especially for the UK economy. First, the country is currently facing a political crisis. Given the narrow margin with which the Leave campaign won the vote, the support for that decision could be challenged from time to time. Next, with overwhelming support to remain in the EU in Scotland and Northern Ireland, their future within the UK remains in question,” said Moody’s.

The rating agency noted that trade negotiations are “rarely smooth”, and that UK-EU diplomacy will be no exception.

“The EU may not entertain significant trade concessions without free movement of people and substantial contributions to the EU budget. Potential restrictions on trade in financial services is a serious downside risk to the UK as the financial services industry represents 8% of the economy in gross value added terms. A decline in this sector will undoubtedly spread across the economy,” said the rating agency.

Moody’s described the potential for success of “Leave” campaigns in other countries as the “real vulnerability” for the EU, pointing to the Netherlands, France and Germany, all of which face elections in 2017, and noting that political risk could rise if populist and anti-EU parties gain support.

“In the long run, the potential strengthening of these movements could have detrimental implications for the continued cohesiveness of the European Union and the euro area, and in the extreme threaten their existence,” said Moody’s.

“The fragmentation of the EU could also encourage protectionist tendencies in a number of countries, and therefore seriously challenge, and ultimately reverse, the past few decades of increased globalization. This in turn would thwart the long-term growth prospects of individual economies and slow the catch-up of less developed countries,” the report said.

Moody’s signed off its paper as follows.

“In conclusion, even though the UK has the second largest economy in Europe, it represents 3.5% of the global economy and its contribution to global growth was only 0.1% in 2015. By comparison, the EU economy represents roughly a quarter of global GDP. Its size makes the EU systemically important to the world economy and the US. Therefore, the materialization of negative risks in the EU would have a significant consequences for global trade and economic growth.”

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