01.07 Weekly Viewpoint : New monetary stimulus lies ahead in the United Kingdom

Many months will probably pass with no significant developments being made in terms of the negotiations between the European Union and the United Kingdom……..

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Intesa Sanpaolo – Research Department For professional investors and advisers only

New monetary stimulus lies ahead in the United Kingdom. The markets’ reaction is not placing the ECB under particular pressures, but there are rumours that APP parameters may be adjusted.

– The United Kingdom’s withdrawal process from the European Union will get off to a very slow start. Official notification of the withdrawal request has been postponed to after the appointment of the new Conservative Party leader and Prime Minister, which should come on 9 September. The European Union has called a EU Council meeting in the following weeks, asking the United Kingdom to submit its request as soon as possible, and rejecting any kind of informal talks. However, it has given no indication on what action will be taken if the request is late in coming. Also, post-summit statements have laid down a crucial condition for negotiations: the United Kingdom cannot hope to retain access to the single market without accepting the free movement of people. On its part, however, the United Kingdom is in no rush at all to start negotiations, as it still needs to appoint a Prime Minister and reshuffle the Cabinet, and no negotiation strategy was prepared ahead of the referendum, due to deeply diverging visions within the “Leave” camp. The new government will have a very tough task, as it will have to decide whether to maintain access to the single market, or to keep the promise of curbing the entry of foreigners into the country and stop transfers to the EU budget. The second option may have smaller repercussions than initially feared on trade flows, but could prompt a partial delocalisation of the financial industry. On the other hand, opting for access to the single market in line with the Norwegian model could be politically unfeasible for former Brexit campaigners, as it implies guaranteeing the free movement of EU citizens. Therefore, an official withdrawal application may have to wait until long after October.

– Should we fear the uncertainty clouding the start, the length, and the outcome of negotiations? While there will be obvious disadvantages (the effect on investment decisions, in the United Kingdom in particular, risks being stronger), one advantage could consist of neutralising the pull effect on other Euro-sceptic movements in the continent – and in particular in Holland, where elections are due in March 2017, and where the PVV nationalists were slightly ahead in voting intention polls. Furthermore, one week after the referendum, it is safe to say that the reaction of the markets to the event has been far from disorderly. The sharp appreciation of the pound is beneficial in terms of the rebalancing of current accounts, and will help mitigate the effects of the slowdown in domestic demand. The plunge of the European stock market indices is more a reflection of investor doubts on the solidity of the European banking system than the result of an assessments of the effects of Brexit. The functioning of interbank markets remains normal, and the risk of peripheral sovereign issuers being impacted by heightening risk aversion has already eased. In fact, in the past few days, the elections in Spain, and rumours of a possible slackening of APP parameters by the ECB, have pushed yields and spread downwards. At this point, any deterioration in the future may only result from other events, and certainly not from the UK referendum itself.

– Before the vote, there was ample consensus on the fact that the decision to exit the EU would have prompted the central banks to adopt immediate stimulus measures. The absence of evident market dislocations casts doubts on this theory. A reaction remains likely if prompted by a worsening of the macroeconomic scenario. The governor of the Bank of England has stressed that, compared to the central bank’s previous projections, the outcome of the referendum will result in slower economic growth and higher inflation; therefore, “some monetary stimulus will be required in the course of the summer”. What is still certain is that the Fed will stay put at least until September, even if the United States will be relatively unaffected. The ECB, on its part, will have to take into account a modest and gradual negative effect on the medium-term economic outlook, and this may create the conditions for a useful pre-emptive intervention on parameters of the APP in coming months.

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