Much of the commentary on the Brexit has focused on the negatives, but as with most things in life, there is a balance.
Change takes time – and the Brexit is a huge task. What this may mean, is that the delays and political dealings, along with efforts from central banks to support economies through the change, may help offset the potential negatives. There are also some signs the initial fears about the Brexit may not play out.
A closer look at the Brexit fears
Fear: The Brexit will trigger other countries to leave the EU
European shares have dropped substantially since the UK referendum because of this fear, but there are some signs the turmoil from the Brexit may actually deter other countries. The Spanish election last weekend suggests as much. European shares are actually cheaper than Australian and US shares based on earnings value and compared to bonds. There continues to be solid growth in Europe backed by consumption and higher government spending to help support companies (and sharemarkets) in the future.
Fear: Countries outside the EU will cut interest rates to manage the turmoil
At the moment, global bonds are valued in anticipation of a rate cut by the US Federal Reserve (Fed) and more than one rate cut by the Reserve Bank of Australia (RBA). It seems unlikely the Fed will cut rates again as its economy continues to strengthen, but there is a strong chance the RBA will cut rates further at its July or August meeting. Bond returns are very low and unlikely to be high from here but Australian bonds are likely to continue to perform better than US bonds going forward. Cutting interest rates is not necessarily something
to fear as it can support investment and consumption in countries.
Fear: UK trade will suffer from the Brexit
Once it ratifies the Brexit and invokes article 50 of the Lisbon Treaty, the UK has two years to renegotiate trade – so at least in the short term, trade should continue as is. In fact, the fall in the British pound may actually help improve trade. While many European politicians have been taking a tough stance in speeches since the referendum, this doesn’t mean actions will follow – particularly if they fear it will escalate the crisis. This means existing trade rules could even extend indefinitely, so trade wouldn’t be affected in the long term.
Fear: the Brexit will trigger a financial crisis
Europe has been strengthening over the past year off the back of an increase in government spending and bank lending – so it looks unlikely it would plunge into a recession and drag the world down. That said, central banks globally are poised and ready to take charge if necessary. The Bank of England is expected to cut interest rates and introduce stimulus, while the European Central Bank is likely to ramp up its stimulus measures. Countries outside Europe are also likely to take the Brexit into account – the US is expected to maintain a hold on its interest rates, while Australia is likely to cut rates and Japan may introduce additional measures.
Aside from this, the financial system is actually on a much stronger footing than it was before the global financial crisis. Tighter regulations and more conservative lending standards from banks mean they are better positioned to manage market volatility (and tighter use of derivatives, a key problem last time).
Back to Australia
While the Brexit may have an impact on Australia through direct trade with the UK and Europe, or may have a negative impact on tourism, it’s not likely to have a major influence on Australia. What is more likely to matter is whether the RBA cuts interest rates, the Australian dollar falls or the stimulus efforts by other countries to support their economies.
In the future
At the end of the day, any major event like the Brexit, is likely to create volatility in markets. And this is exactly what we’ve seen so far. The key is considering the longer term in working out what it means for your investments. Sometimes, market volatility can be an opportunity.
Commentary provided by Tim Rock, Head of Market Research and Strategy, BT Investment Solutions
Information current as at 29 June 2016
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