Andrew Cornell says the worst case Brexit knock-on effect for the global economy and banking industry would be a large-scale retraction of globalisation and a retreat into simplistic nationalism

By Andrew Cornell*

There are two particular groups devastated by Brexit: British pollsters and Japanese policymakers.

The former because they have now surged ahead of economists as far and away the worst forecasters on the planet, having got the last two huge votes in the UK disastrously wrong. 

The latter because a fragile, stumbling economic recovery has run on the smell of a declining yen and the Japanese currency - still considered a safe haven - surged over 10% as investors abandoned British and EU assets in favour of the yen (even though negative interest rates in Japan might mean investors actually pay for the privilege).

This is the nature of the Brexit ramifications: often unpredictable and of uncertain significance. For the global banking industry, neither is desirable. 

An overarching concern is global growth, already weak. Banks are leveraged plays on economic growth – the more trade there is, the more investment, the more employment and spending, the better banks do. 

Brexit may lead to a recession in Britain, contagion in the EU and weaker activity globally as confidence and predictability suffer blows.

As we see it  

Joachim Fels, managing director and global economic advisor at PIMCO, one of the world’s largest bond investors, summed up the prevailing views on the cyclical (six-to-12-month) and the secular (three-to-five-year) horizons: “As we see it, the impact on global growth and inflation on the cyclical horizon is likely to be relatively small – and almost certainly not large enough to push the global economy into recession. 

“Even if the UK fell into a recession, which is a distinct possibility, the direct knock-on effect on global GDP through lower UK import demand would be minimal as the UK accounts for only 3.6% of global imports of merchandise goods and 4.1% of global imports of commercial services.” 

Along with most informed observers, he says a dampening of trade effect and business investment around the globe is likely due to the heightened uncertainty about the global implications of Brexit and the tightening of financial conditions. 

PIMCO estimates the trade and investment effects combined could lower the trajectory for global growth slightly in the next couple of quarters but not by enough to cause a recession. 

For the Eurozone, which would obviously be most affected by Brexit after the UK, they estimate a negative impact on GDP of around 0.3%. The effect on the US and other regions would likely be smaller.

Bitcoin up

For the financial services sector globally, there are some immediate impacts but they are contained. Banks raise money from depositors and more caution often translates into more people putting cash in banks – but bear in mind the value of the highly volatile, crypto-currency Bitcoin also surged as Britain voted to isolate the continent.  

Banks also raise money on international credit markets from institutional investors and it is these markets which are most likely to be disrupted in the short to mid-term. 

Once the initial volatility settles down, Asian banks might actually be seen as better credit risks relative to European banks with better funding. But they could also be seen as more threatened by a global slowdown hitting emerging markets harder. 

The Institute of International Finance, the global banking club, noted “safe haven assets have benefited, with yields on major government bonds falling further and the Yen and $US strengthening. Within emerging markets, the biggest losers have been in Emerging Europe given their close trade ties, as well as Mexico and South Africa - the usual victims of market stress.”

 Coincidentally the global banking regulator, the Bank for International Settlements, held its annual meeting just as Brexit hit the headlines. The official statement from the BIS was “the outcome …has resulted in high volatility in markets”. 

“Extensive contingency plans by the private sector and central banks have been put in place to limit disturbances in financial markets,” the statement said. “Stronger capital and liquidity buffers in the private sector have also made financial systems more resilient.”

“Central banks have already communicated that they are closely monitoring the situation and stand ready to take the necessary actions to ensure orderly market functioning.” 

The BIS too forecast a period of uncertainty and adjustment, exacerbated by the central role of London as a global financial centre (indeed that is already a point of focus with rival financial centres such as Singapore and Hong Kong putting up their hands to take London’s role, although given timezones Frankfurt is the more likely beneficiary of banks shifting their EU centres of gravity). 

Stress testing undertaken by the US Federal Reserve and announced over the weekend also testified to greater resilience in US banks. 

Bigger challenge

The longer-term challenge for banks would be if degrading global growth led to corporate failures and bad debts but such an impact of any scale would require a pronounced downturn either globally or in particular sectors (where it would hit major bank lenders). 

By far the most worrying implications go beyond those evident in financial markets, driven by a protracted period of political uncertainty. 

The most-dire situation for the global economy and hence the banking industry would be a large-scale retraction of globalisation and a retreat into simplistic nationalism. 

That would crunch trade flows, domestic and cross-border investment plans, consumer and business confidence and the local economies ‘nationalism’ supposedly appeals to. 

As Triple T Consulting’s Sean Keane noted in his regular What’s happening in the Money Markets? Insight for Credit Suisse: “Potentially the worst long-term outcome for both Australian and New Zealand, and for all nations that that rely on Free Trade Agreements and open markets, would be a President Trump/Brexit combo (Trumpit)”.

“Both of these votes would represent a rejection of the post-war consensus on increasing access to open markets, on reducing border frictions and on maximising the benefits of comparative advantage.” 

“Each of those things have benefited developing nations, and all have been very beneficial to Australia and New Zealand as suppliers of hard and soft commodity product to the worlds markets.” 

Is Trumpit likely? Watch the UK polls. And bet on the opposite.

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*Andrew Cornell is managing editor at ANZ's BlueNotes. This article first appeared on BlueNotes here, and is used with permission.

PS: Iceland 2 – England 1. Out of the EU and the Euros in three days… imagine what a quinella on that would’ve paid.