U.K. Votes For 'Brexit'

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Summary

Market consensus appears to be clear that, over the short term, the decision to forego EU membership will likely lead to weakening of sterling and impact U.K. economic growth.

In the coming weeks and months, there may be delays in consumer spending, companies’ recruitment and foreign direct investment as the nation and wider global economy digests the decision.

More broadly, we believe the best businesses will be well-equipped to deal with the challenges wrought by Brexit.

What does this historic decision mean for U.K. markets?

By Nick Mustoe, John Greenwood, Arnab Das, Mark Barnett and Jeff Taylor. Posted on Expert Investment Views: Invesco US Blog.

Following the U.K.'s historic decision to leave the European Union (EU), we share the initial views from several of our investment and economic experts in the U.K. as to what this result may now mean for the markets.

Nick Mustoe, Chief Investment Officer, Invesco Perpetual

After months of anticipation, U.K. voters have decided - in a historic move - to leave the European Union some 43 years after joining its predecessor, the European Economic Community, in 1973. The U.K. government, institutions and wider business community now have the task of addressing a multitude of financial, economic, fiscal and political implications and consequences.

In our view, the decision to leave will likely increase existing market volatility in the immediate aftermath, which was driven by investor uncertainty over the potential consequences of the outcome, and may see investors moving further into defensive assets. This type of market volatility often leads to price adjustments that are indiscriminate, and can therefore present attractive buying opportunities for fundamental, long-term investors, in my view.

Market consensus appears to be clear that, over the short term, the decision to forego EU membership will likely lead to weakening of sterling and impact U.K. economic growth. The extent of such an impact and how long it will last can only be speculated on at this time. The more immediate impact on the U.K. economy and growth will likely be determined by several domestic and global factors, from trade, productivity and capital investments (domestic and direct foreign) to the direction of central bank monetary policy.

Longer term, we believe the U.K. economy will not only be able to handle the decision to leave the EU, but continue to thrive as we remain optimistic about the U.K.'s growth outlook. Having experienced some of the strongest growth among the G7 nations over the past four years, we believe the economy is well-positioned to handle what lies ahead.

John Greenwood, Chief Economist, Invesco Ltd.

Now that the voters have had their say and have opposed the establishment consensus to remain in the EU, the action will switch to the markets in the short term and to the government, Parliament and the negotiations with the EU over the terms of exit in the longer term. I expect sterling to experience an immediate fall of perhaps 10% to 15%, but the euro could also be adversely affected as investors assess the possible knock-on effects on the EU and the eurozone. Most likely, in my view, the US dollar, Japanese yen and Swiss franc would be regarded by investors as preferred "safe havens."

In the near term, the current administration of U.K. Prime Minister David Cameron is likely to undergo a significant shake-up to reflect the views of the victorious Brexit rebels. These changes could even include the departure of Prime Minister Cameron, resulting in a Conservative party leadership contest. (Editor's note: After the vote result, Prime Minister Cameron announced his resignation.) Even so, simply changing the prime minister and members of the cabinet could prove inadequate, and the country may demand a general election. The Conservative party may end up divided, giving rise to the possibility that Labour is re-elected but opposes the result of the referendum.

Next, there is the very real problem that although the electorate has now voted for Brexit, up until the referendum Parliament was solidly in favor of remaining in the EU. Since under the British constitution it is Parliament that is sovereign, Parliament cannot be counted on to pass the necessary legislation to implement the break from the EU.

Finally there will be extended and no doubt tortuous negotiations with the EU to establish the new modus vivendi between the U.K. and EU member countries. These talks will need to cover trade, investment, regulation of products and services, migration, security, and a host of legal matters from human rights to the health care treatment of Britons in the EU and EU citizens in the U.K. Many of these agreements will in turn require new legislation. The new administration will have its hands full.

Arnab Das, Head of Emerging Market Sovereign and Macro Research, Invesco Fixed Income

Now that the U.K. has decided to leave the European Union, we believe it is impossible to be precise about the economic consequences of this decision, although a number of official studies have come to relatively specific conclusions about the economic and financial costs. High uncertainty will likely result from the intangibles, which are many: Bilateral U.K.-EU exit negotiations will likely take at least two years, under EU and U.K. law, but the timing of that decision could vary, and the negotiating stances of the U.K. and EU could range from friendly to contentious.

Negotiations with other trading partners will also likely need to take place. Otherwise, the U.K. could face higher import tariffs or other barriers to exporting to the rest of the world - even if it pursues the unilateral trade liberalization that some "leave" campaigners have suggested. Such negotiations are likely to be complex and could take many years, based on previous experience.

The underlying question for U.K., regional and, indeed, global economic and financial performance is whether the ultimate destination will be for little change, more opening, or higher barriers in the trade and investment environment in the U.K., Europe and, by extension, the world economy.

Mark Barnett, Head of U.K. Equities, Invesco Perpetual

In simple terms, the U.K.'s vote in favor of Brexit has cast us into uncharted waters with a level of uncertainty we have not experienced for a long time. In the coming weeks and months, there may be delays in consumer spending, companies' recruitment and foreign direct investment as the nation and wider global economy digests the decision. In combination, these factors present substantial short-term headwinds to the U.K. economy.

Over the longer term, however, we believe the U.K. economy can cope with life after Brexit, and we remain optimistic about the future outlook. We have a dynamic economy that has adapted to change before - and is now primed to adapt again to whatever change is thrown at us.

Sterling will be a key instrument to watch over the near term, as movements in currency will likely determine the extent of the wider market response. We expect the initial sentiment to be negative and expect a fall in markets, but the question is - how much? We have seen quite a lot of weakness building already, so some of the negative sentiment will already be priced in. There will likely be a knee-jerk response, potentially followed by a rally in the market as people start to think more carefully about the wider implications of weakening sterling.

If there is a sharp fall in sterling, many U.K. companies - particularly international large caps with predominantly overseas earnings - could reap some tailwind benefits as currency translation feeds through into earnings.

More broadly, we believe the best businesses will be well-equipped to deal with the challenges wrought by Brexit. U.K. companies have withstood the numerous and variant headwinds of the recent period - where discussion around US interest-rate policy, the direction of the US dollar and commodity prices have contributed to hostile market conditions.

Jeff Taylor, Head of European Equities, Invesco Perpetual

The U.K. had its say and decided to leave the European Union. The focus will now shift to the intended transition period and the negotiations between the two parties (U.K. and EU), which will take considerable time.

The real extent of the impact on the broader European economy and political environment is uncertain. Markets do not like uncertainty, and so we expect market volatility on both sides of the Channel. In economic terms, we see less risk of lasting damage to the rest of Europe given that the eurozone recovery, driven by domestic demand, has shown itself well-positioned to withstand external risks as demonstrated in the last couple of years. Some damage to broader European growth cannot be excluded, but we would not anticipate that the whole continent will automatically slip into recession because of Brexit. The European Central Bank (ECB) and the key politicians in Europe (e.g., German Chancellor Angela Merkel and French President Francois Hollande) know the risks and will more than likely use policy to counteract near-term stress. What form that takes remains to be seen, but it is highly unlikely they stand on the sidelines and watch the market panic.

On the political front, we think it is wrong to see Brexit as a trigger for the complete breakup of the EU. Near term, we expect political noise as both France and Germany have general elections in 2017, and neither country can therefore afford to give the U.K. an easy ride. On the Continent, that some populist politicians express anti-EU views does not mean that a series of follow-on referenda is a given. It has been wrong historically to underestimate the commitment of European politicians/institutions to the EU project (e.g., during the sovereign debt crisis in 2012 and Greece in 2015); all the periphery countries are still in the EU and playing by the rules, despite the rest of the world predicting they would have exited by now. Populist risk exists globally (not least in the US) and is not a factor unique to Europe.

It is worth remembering that the Brexit vote has been well-flagged for some time, and while the end result is a negative surprise, flow data in the European markets pointed to significant nervousness already, ahead of the result.

Read more about Brexit from our experts.

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UK votes for Brexit by Invesco US Blog