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How Brexit Will Affect the European Economy in 2017

Brexit Affect Europe - Vintage Value Investing

European investors have a busy week coming up.

British Prime Minister Theresa May has made clear that she intents to begin Britain’s departure from the E.U. by triggering a provision of its treaty known as Article 50 before the end of March. A bill authorizing the government to do so is moving through parliament this week. This is likely to keep pressure on the weakened pound.

Meanwhile in the Netherlands, the anti-Muslim nationalist party – which wants the country out of the E.U. – is now second in polls to the conservative party of the current prime minister. The election is going to be held this Wednesday March 15th. Although the nationalist party isn’t expected to gain power, investors would probably interpret strong support for him as a mark against European integration, pushing Dutch yields back up.

And then later in the year, we have elections in France, Germany, and potentially Italy.

So 2017 is likely going to be a very important year that will determine the fate of the European Union and the euro.

But the most important near-term event is what’s going on in the U.K. and the expected triggering of Article 50. Here’s what you need to know (as described by Vanguard):

What You Need to Know About Brexit and Article 50

What’s going on

  • The Brexit referendum happened 6 months ago, but the United Kingdom (U.K.) is likely to actually begin its formal process of exiting the European Union (E.U.) this month by triggering a provision in the treaty known as Article 50.
  • However, investors should expect Brexit to be a drawn-out process as negotiations between the U.K. and the E.U. are likely to take at least two years.

Why it’s important

  • Many economists worry that the Brexit process will damage the U.K. economy over the long term. Although the U.K. economy has held up well since the Brexit referendum last June, analysts are watching for signs of slowing growth later this year as Brexit unfolds.
  • Another key concern is that other countries may follow suit in leaving the E.U. Anti-E.U. sentiment, which seems to be spreading across the European continent, could influence elections later this year in the Netherlands, France, and Germany. In short, 2017 could be a decisive year for the fate of the E.U. and the euro.

What to expect

  • In addition to the possible near-term economic impacts of Brexit, we believe European policymakers face many long-term headwinds as they try to restore their economies to full capacity.
  • Issues that spawned Brexit—including growing nationalist sentiments and the migration crisis—will likely continue to make life difficult for policymakers for some time to come.

Vanguard expert shares his views on Brexit

Peter Westaway, chief economist for Europe, recently discussed the potential effects of Brexit and growing anti-EU sentiment on Vanguard’s economic outlook for Europe in 2017 and beyond (the transcript is below, followed by the actual video of the interview).

Peter, the United Kingdom is expected to begin negotiating with the European Union over its exit shortly. What’s occurred thus far, and what would we expect in the near future?

Peter WestawayPeter Westaway: It’s interesting because it’s over six months since the referendum happened, but the government is expected to trigger so-called Article 50 in March of this year. That starts the formal process of the U.K. leaving the EU [European Union]. The actual leaving of the EU may then not take place for another two years after that, so it’s quite a long, drawn-out process.
And as far as its impact on the economy is concerned, most people think that over the long term, this is probably going to be quite damaging for the U.K. economy, that it’ll probably require our GDP to be lower. Just how much lower is going to very much depend on whether or not the U.K. has what’s called a “hard Brexit” or a “soft Brexit.”

It’s now looking more likely to be a hard Brexit. And what that means is that because the U.K. wants to restrict immigration, it probably means we won’t have such good access to trading relationships with the EU. So that’s probably why we think activity will be lower.

So far, though, since the referendum, a lot of people, myself included, thought the activity was going to be hit really bad, a bad hit to confidence, companies would stop hiring people, stop investing. In fact, the U.K. economy seems to be sailing through it all very nicely. But I think it’s maybe too soon to say everything’s fine. I think we will expect to see slightly lower growth next year going forward as the real impact of Brexit starts to set in.

Did we anticipate any type of policy reaction in response to the Brexit and to potential slowdown in growth?

Well, we’ve already had the Bank of England cut interest rates pretty soon after the Brexit vote, and I think that helped to shore up confidence. Ironically, it also helped to weaken the exchange rate, which is also propping up the economy. I think fiscal policy is a lot looser than it otherwise would have been, so all of those things may be helping to explain why growth hasn’t fallen away as sharply as people were expecting.

There’s a growing anti-EU sentiment on the heels of the U.K. Brexit vote and the U.S. popular election. What are the implications for the European economy and our economic outlook in 2017?

Yeah, but I think the big worry is because the U.K. is now thinking about leaving the EU, it might embolden other countries to do the same thing. And so there are a series of political events coming up over the next year, most important, the French election for the new president, the German election. And any one of those could allow this anti-EU sentiment to express itself. And in extreme, that could actually cause a government to fall or even a country leaving the EU or the euro. I don’t think we’re going to see that, but all of this uncertainty just undermines the growth picture and it just weighs down on growth in the euro area to an extent.

So what policies do we expect out of the ECB, for example, to support growth?

Well, we’re seeing continuing stimulus being provided by the ECB. They’re adding to their process of quantitative easing, which is asset purchases. That’s expected for the rest of this year.

And many people are also looking to governments to provide some policy stimulus in the form of fiscal injections. The reality is that with those general elections coming up in Germany and elsewhere, we’re probably not going to see that help from government. So it’s probably more likely to be the ECB that continues to do the main work in helping the European economy.

So, do we expect the ECB to be successful in supporting growth in Europe?

What we’re seeing with quantitative easing, and to an extent with negative interest rates as well, is that policy has been working very slowly, very gradually; and many people think that the more you do QE, the less effective it becomes.

Even so, I think we are gradually getting a return to full capacity in the euro area. But inflation is still well below target, so there’s still a lot of work to do. So I’m not an outright pessimist on policy, but it’s a long haul. And these headwinds like Brexit, like anti-EU sentiment, the migration crisis in Europe, all of these things are making life more difficult for policymakers.

Video Interview:

Vanguard’s Economic and Stock Market Outlook for 2017

For more key insights on what to expect in 2017, check out: Vanguard’s Economic and Stock Market Outlook for 2017.

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