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Brexit: After the Vote

2016-06-28

The UK's vote to leave the EU sets in motion a series of complex adjustments for the UK and Europe that will take years to play out. Huw Pill, chief European economist in Goldman Sachs Research, discusses the economic and market implications of the Brexit vote.

This podcast was recorded on June 27, 2016.

All price references and market forecasts correspond to the date of this recording. This podcast should not be copied, distributed, published or reproduced, in whole or in part. The information contained in this podcast does not constitute research or a recommendation from any Goldman Sachs entity to the listener. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, as to the accuracy or completeness of the statements or any information contained in this podcast and any liability therefor (including in respect of direct, indirect or consequential loss or damage) is expressly disclaimed. The views expressed in this podcast are not necessarily those of Goldman Sachs, and Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by Goldman Sachs to that listener, nor to constitute such person a client of any Goldman Sachs entity.

Copyright 2016 Goldman Sachs. All rights reserved.

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This is extra We, the Goldman Sachs for people from our firm shudder, incites on developments currently shaping markets industries in the global economy objects. You would go ahead of corporate communications here, the firm The UK is vote to leave. The European Union has Herbert it around the world who pill chief european economies. The Goldman Sachs is here to help us make sense of the ramifications of abreks it who welcomed the problem. too much so here the UK referendum on whether leave the EU was top a mind issue for months, but this vote to leave started many people by surprise. How gee characterize the early market response to the bricks. It will clearly many UK acid prices, not least the exchange rate moods quite dramatically on Friday morning, as we progressive, saw the results coming in and
growing likely hers and eventually the reality that we were going to see about to leave rather than remain. no true. The markets have rallied ahead of that equity markets, panda strengthened in expect, nation over remain vote and maybe there was a little bit of complacency on the side of markets, would be. The outcome so we saw very dramatic reactions which largely unwound the previous run up. If you kind of a slightly longer perspective, maybe across the two weeks surrounding the referendum, probably there, you see less dramatic moves, and we ve seen a sort of subsequent sell off over the last couple of days, which have moved as further on What I would say, though, is probably what's being encouraging only somewhat reassuring relative to say the post layman environment is the we see a lot of volatility in us at prices. Are we?
big moves in ass at prices, markets themselves have continued to function quite well. We haven't seen the sort of seizing up of markets while the gathering of prices or the inability to sell securities at any price that form of kind of extreme liquidity that seem to characterize, say the periods in the fall two thousand fascinate after the failure of layman earning as long as there's ability to trade a prices being set, the reprocessing, a low pay for those on the wrong side is probably a healthy reaction to something that fundamental of has changed and the functioning of markets and the support provided that functioning both by the private sector and the authorities, I think, has helped to facilitate probably see your team in Goldman Sachs Research has estimated the uncertainty surrounding breaks. It will save about half a percentage point from GDP for the UK this year, and another one point. Eight percent points next year so
implies a mild recession for the early part of next year. So, what's driving that slow down will for sure me. We woke up on Friday morning with a leave those but nothing concrete to changed overnight UK still a member of the EU. The european law continue to apply in the? U K, british firms continue to have access to the single so we haven't really initiated or even started the winner in another was I'm table for, by which those things will happen yet. So I think you can't look to change your full forecast, especially the forecasts over the next couple of years, on the fact that trade or financing or movement of people is gonna, become more difficult because the reality is it's not concretely liking to become difficult over the horizon. Salaries are we ve, mainly bogged down are forecast is because there, as a result of the leave vote. Being a considerable share,
and uncertainty shock to the economy and the financial markets in the sense that financial institutions, market participants, businesses, consumers they don't know what regime there going to be working in into or three years time. They don't know whether the british friends will continue to have access to markets in Europe at that eyes and on the same basis, they do today, We don't know whether cross border financial transactions that horizon Cancun. Need to be made under the relative freedom. Their able to eight today, Because of that we think the war there's so much of uncertainty. There's an incentive to postpone your investment decision to postpone your spending decision to postpone that building the factory to serve the european market? In the? U K until we know what form of access the goods produced in that factory will have into the single market in Europe, and is that postponement of activity, maybe just delaying it. Maybe if
certainly resolves in a way that makes it unattractive to to operate in the UK. The the eventual cancellation of activity in its transfer to another part of Europe, but really the essence that, in the face of uncertainty, alot of activities are just not going to take place now and that leads to quite a sharp fall in activity. In our view, given the extent of wood, there are known unknown Hetty model. The impact range of outcomes. Wasn short answer is, is difficult and economists Used to working in an environment where maybe the rules, the legal framework and so forth, he has given and they were looking at other factors. One of the difficult things about abreks it scenario is that lots of things that we too, you take for granted a suddenly up in the air. Now we set about doing it. Well, we ve tried to construct measures for how the private sector the financial markets, the man in the street view uncertainty
we ve taken, for example, measures of imply volatility and stop prices. The famous VIC's uncertainty index Roma, the financial crisis Also, you know Dunwood searches across british newspapers to find out how much they talk about uncertainty or volatility in constructed indices. On that basis, we looked at other actual market spreads. Each of these things seem ass, to give some important gauge of uncertainty and in other co move so that some sort of suggestion that that picking up something which is roughly of the underlying uncertainty in the economy. We ve been various efforts to extract back Movement and try and related to other macro economic burials growth, inflation demand, consumption and so forth. Confidence and we ve used that type of analysis spread across a variety of different episodes in a variety of different countries to try and gay On average, the economy responds to uncertainty, now trunk of a boy
more of a focused view of what's going on in the U K, because in the end this is specifically UK question. We ve also done a number of analyses using that framework focusing on three key episodes, which we characterizes examples of uncertainty in the UK economy recently where, in the last twenty five years, the first is the exit Britain from the exchange rate mechanism backing ninety ninety two. The second is events around. scottish referendum, which took place on independence in Scotland that took place about eighteen months ago, and the third is the impact of ants certainty where we try to isolate the uncertainty effect from all the other effects. Following the you're, really when in two thousand seven to vaccinate, and so it gives you factual vodka, where the scottish referendum on Uk Gdp as a whole had relatively little effect. Where's the financial crisis and the uncertainties associated with that had a very big effect now goes out. Begs the question.
what's. The magnitude of uncertainty were facing now. How does a kind of calibrate against those three examples and nobody look at the decisive measures we have constructed. It looks more like it's a sort of her post limit certainty shock than a post scottish referendum, uncertainty shop- maybe not surprisingly, and so as a result, that's the basis for the sort of numbers that we come up with about a two and a half percent for the level of gdp over two years, which translates into this one point: eight shaving that you describe in your question. So one thing it's easier to the impact on the currency, and so the pound fell to its lowest levels. in over thirty years after the results were announced. How do you see bout risk between the inflationary, of the currency decline and the benefit it might give to? Uk exporters will ever left
clearly, a weaker currency, other things equals gonna boost import prices into the UK, and we have raised our view on inflation, the UK, as a result of the sharp decline we ve, seen over the last few days following the vote to leave in the referendum and that may limit the ability of of monetary policy you have to starve, keep in mind that we are starting from a situation in the UK. As we are another pet the world where inflation is low and not just low but undesirably low in the sense that is well below blows hard. It ran up the Bank of England in the UK, skater set. So from that perspective, and, of course, is a very narrow perspective from the perspective of getting inflation back to targets, arguably, the higher simple prices coming from the depreciation of currency helps in some sense now. I would also say that, because we have this combination of higher inflation coming from the simple prices, but
so the downturn in the economy that we discussed a moment ago mean that two in the economy is going away on inflation. Other things, equal, it's gonna leave more slack in the economy with otherwise would be the case, and that will mean low wages, lower cost of atoms, lower price inflation. So so I think the important to say is overall, is a balance between these two things in our inflation outlook, and we do have. I M going up more quickly than we had in the past, but we don't really envisage a kind of big overshoot, the inflation target. So we don't think that's going to limit the bank England, scope to ease monetary policy and support the economy in the face of the uncertainty shock in the downturn in demand that I described once more, I think either inflation were to overshoot in the short term. We think The Bank of England is credible enough in its commitment to get inflation back to target sailor. Three or four arise and that it would be prepared to allow that overshoot.
for it wouldn't be deterred in keeping the support for the economy in place through lower interest rates, more ass, it purchases and other measures of simulator. Economy, even though maybe there is a moment when inflation is going above the two percent target, so I think the important The is that the degree of freedom the Bank of England has is probably relatively high Turning to your point about exports is I mean a week currency should improve price compassionate, should support. Exports is a thing, though, that you have to take into account that the structure the UK economy is is a bit distinct from many other economies. Advanced economies in general, but also specifically in Europe unless, partly because the UK has specialised to some extent in the financial services and financial services are less of a lower cost basis,. The financial services in this case is being offset by the answer:
to around one, can actually function right. I think that's true. It's also true. I think in general that services of that type a letter so yeah yeah, the not so said the demand for the Europe from other parts of the world. Other parts of Europe, the british Financial services, is probably less sensitive to the exchange rate and so forth than would be say. The demand for manufacturing gets their produce in the UK. I mean Polly, reflecting the fact that a lot of financial services business is conducted in hot his, but also because of the type of firm salary sensitivities and so forth and other costs. Sensitive issues is not so great an exchange rate. So we wouldn't expects to see that much support in the aggregate coming from a weaker exchanges, certainly some at the margin. What that means is that probably the dominant effectual, we change, raise really coming through an onto higher inflation and that the supporter effect for activity is really coming
these monetary policy and its effects on domestic financial conditions, rather than strongly to exchange, see said the Bank of England has, as a range of options available to name said: all options will be explored going forward, they ve, We take some steps to ensure that the market continues to function smoothly, which it has to date. How do you anticipate there policy evolving over the rest of the year and how are they going to use the flexibility that they have? What I I think they're I would distinguish with two set, supposing maybe he's a little arbitrary. I think in terms of supporting market, nay, ensuring the, even if as a substantial re pricing of assets, that reprocessing of assets takes place whether by sellers on both sides and markets, a functioning in an orderly way. I think the banking and indeed other central banks around the world, will do quote whatever it takes to quote Mr Draghi Roof remarks,
You like twenty job. They will do whatever it takes to ensure that preventing one of the big lessons of the two thousand. Seventy thousand eight experience the Northern Rock the postal, be when it so itself off is what to allow markets to seize up. You don't allow retraining of assets. You don't allow the price formation take place, then you can get yourself in a very difficult place to extract yourself. So I think in that dimension they will use all options that they have lots of options. They built up a whole machinery conjunction with our colleagues in other central banks, which is being employed and will continue to be employed. Separate set of issues, is what they might do with more. If you like traditional macro economic measures in two towards monetary policy, we expect them in the coming weeks. Once the market is settled, both to cut interest rates in order to support the economy, nor any weaker sterling and the right
inflation that we anticipate in the coming years, owing to the depreciation cutting rates to make domestic social conditions easier than their otherwise would be. In order to support the economy, I think, is an important element of what they can do, underpinned situation and have it on the asset purchase side watching, citizens. Yes, we do expect them to restart ass it purchases, the Bank of England, as Sir, has suspended them. If you like, I think, probably more importantly, and probably the first line of defence, what we expected who is move away from just buying sovereign assets, which is what they largely done in the past, to buying more private us, its corporate asset, similar to what is he based on. I think that's right, and I think the main reason is that an opportunity to squeeze corporate credit spreads and so provide easier, financing, conditions for key What are the real economy in the UK to sustain demand? Sustained investment in well as we discussed earlier, is quite a difficult environment, but at this time take measures that armed props, through
we'll cutting red is putting further downward pressure on the exchange rate. So at the time when the exchange rate has been too creating a lot and you dont want to fully undermine confidence in your currency by seeming to sort of be cutting rights into an average appreciates the exchange rate. think using these credit using measures is a way of supporting the domestic, with running less risks on the external side, so We talked a lot about Europe. Unfortunately, for Europe, this vote was just one part of wits very challenging period. Really, since the financial crisis in two thousand eight the easy be as adopted, some pretty unconventional methods as part of its efforts to get the block Silvana on a firmer growth. Trajectory how do you see their response to what is happening in the wake abreks at playing up? Well, I think again in terms of keeping markets functioning, think the lessons learned from the post layman period means that these you will do everything it has to do to ensure that nothing in
sort of immediate mechanical side, of responding to the knock on effects of said. That probably means providing ample liquidity to the market. Wishes is already done it in the process, doing it also, crucially, I think means providing, as other central banks are doing, swap lines the Bank of England and receiving swap loans back from the Bank of England, such that banks in countries which are sterling base banks, for example, they'll have access to euro funding, dollar funding in funding and so forth. So we don't get again this this careful candidates going from mismatches on the fund in the FED is cooperating on that right is why not and other all the leading central banks have go in that direction? No review. If you turn to the macro side, we I think these he be sees as we do. The breaks it is a negative shock to demand in the Euro area. Are does the euro growth is around one and a half percent without breaks, it breaks it. We see- probably shaving off two tenths of a percentage point of growth is here now.
To dramatic, and it certainly not catastrophic compared to some extent We ve had in Europe over the last decade. Nonetheless, if you only growing at one and a half percent, two tenths of a percentage point is not something that you can just idly treat with complete neglect. So we do think that be some response from the easy be. Of course, you see he has already got negative interest rates of the very short and negative policy rent, an aggressive asset purchase vote, which is allowing the yoke of some of the safety given in the Euro area. The bond curve is already very flat and is also on corporate ass, it slow things so it's degrees freedom for movement, maybe a more limited on these sort of types of policy measures. So we d, think these you be will do more, but maybe we'll do more bright, slowly, extending the pace of purchases, extending the dude should the purchases in terms of no longer stopping as they currently signalled in March seventeen, but going beyond that
changing the composition of purchases towards the riskier assets, both more periphery purchases and more private corporate purchases, rather than just buying the safest sovereign debt, I would also say- and maybe this is this is one thing were. We also expect some of this. In the UK there is a tendency to focus lots of monetary policy, and that's natural for people. Operating financial markets was monetary policies with the most immediate macro economic policy to what we are doing, but I would also expect to see some easing of fiscal policy in response to break both in the UK and in the Euro area. So other than the sort of under their under this leadership or another incoming wash up. Nothing in the? U K, probably more and under the incoming leadership. Aren't you of Europe in the Euro area in France, Germany and so forth. I mean what we're going to see. There is, in my view, the steady reaction to the downturn in two thousand and two
and twelve in the Euro area, where we saw economy turned down and fiscal policy was tightened quite significantly in some countries at the time of the Troika meeting much worse there now There may have been rationales for that voting in terms of demand. It certainly deepen the recession in those countries. I think that's not an experience will likely to receive it'd now, so I think monetary policy will do more but to some extent the heavy lifting on sustaining Euro area demand with less companies. He be and will come from the fiscal effort, the EU just released data showing that it? Finally, surpassed its previous high of two thousand it. Or you seem to be saying- is that if monetary CS, why and well coordinated, and the impact of bricks. It is significant, doesn't pushed the EU into negative growth that the EU? What the storm next couple years, working on that those are based case Roy. What risks to that? I think the key thing we Take the view is we we ve been expecting you to me
around one and a half percent, I mean that's above trend What better, where we ve been. It's not something to get too excited about frankly, but nonetheless it of a recovery in the right direction. Clearly, but other things. Equal is a challenge to that. So that is a downside risks, but if breaks, it is basically limited to this type of uncertainty shock, which is logical. in the UK, and then spills overthrew weaker external demand into the Euro area, for example, less strong demand for european exports. In the UK we have probably eligible risk and a combination of monetary and fiscal policy, improbably manage that of set it. Ultimately, so I think the big answered risk is really in this context, the breaks it triggers a political reaction which puts into question some of the progress that has been made on building the back, stops and improved governance and building. your ability and reliability of the wider EU and in particular,
of the Euro area. So when we went through the two dozen eleven two thousand twelve crisis in the Euro area. What happened was at a time and there was a need to try to address policy issues as an and governance issues before, in fact, governance, lectures began to melt away in Europe, and so even when pie these were available to do something, we could have done as it purchases at these. He be at that time we could have had easier fiscal policy, it was impossible to deliver those talks of stabilizing policies because the governance structures, the trust between comes, is always going in the wrong direction. Sought. that remains the sort of big threat, Mr Dry the EU should be the banking union. The single supervisory mechanism new machinery, the the European stability mechanism. These back stops this new. Process of my. We ve taken out some of the sort of narrowly market and financial risks, but what's happened as we kind of double bow,
on managing the political risks, I won't breaks? It shows you and, if particular breaks it is an inspiring for other countries in the EU, in particular countries in the Euro area to move down the route of having referred, considering exit and so forth and so on. I think all those sort of Arrow financial Buck stops them in place there not really well designed to deal with these political challenges, so the biggest the Euro area from domestic sources remains a sort of institutional political governance risk and Europe can give us a good deliver. The growth dynamism onto worship, innovation that creates jobs for the ten percent of the European Workforce. That remains an employed even after this recovery that origin can place, The political dynamics gonna go in a way that we're gonna see forces to change the system which even the c b and Mr Draghi, and always the machinery and build that will be able to contain. So I think that's the biggest risk that wouldn't
our base case. I knew we were not sitting on thinking that the Euro area's tinder box, which is about to explode in the way it did in two thousand and eleven two thousand and twelve what has been learned from that experience, in particular learned that you don't? I repeat, that experience I wouldn't go too far in that direction and paths, The main lesson drawn by other countries and politicians in other countries from the bricks of experiences is don't have referendums. Unless you know what the answer is no with such an uncomfortable combination that you describe the political economic uncertainty wing, what are you will be watching most closely to determine how things, will go from here: well, Given what I said just now, to go about understanding weather is risks come from above, environment, speaking as economist, the already
I think you really need to be looking at these institutional and political factors. Maybe economists are uncomfortable in focusing on those, because perhaps they don't think they understand them as well as they understand you know, financial dynamics or real GDP dynamics of gross dynamics, things that were comfortable with and we have models for and so forth. What are the challenges for us, an example of ensued, He is one of the ways we set about to do that. As we discussed earlier. One of the challenges us is to work out how to who opera into an analysis and our framework, something that isn't narrowly economic. now with our minds when I go to look out, can think was next stress points in Europe. I am addressing. The reality is probably that Strasbourg is a political stress point not a narrowly extra s boy and where would I be looking for it? We just had the spanish elections. I mean interests the spanish elections seem to some extent to be a response to
breaks it a moon. We don't want to go that way, right I don't know. Maybe Spain is of a different explains, very pro european country and so forth, early. Their issues in France in German. with rise, a populist parties now that's managed, but if I was look for a sort of whether next flashpoint is, I think it probably is ITALY. They have a referendum coming up in ITALY in October. Mr, These incumbent government is essentially a pro reform pro EU government did, you said troubling. local elections for surfing Europe. From our perspective in thinking about, where Is it that you could see a political flashpoint? The would create a disturbance in markets where Mr Draghi can sort of, manage the symptoms, but he can't manage the cause. I mean, I think, probably that's and exploited. In October is what now, for five months away,
but so far the market isn't really you. Nothing spreads blow out unease in some of these countries in the way you dare even entwine TAT Edward, and I think that that remains of a baseline view and that's going. But what you said earlier that that's very much part of the year that the sort of forecasts that we have the yes I will. dresses yes, there are many remaining challenges in Europe, so the growing at one and a half percent and sort of managing our way through breaks it in the way we discussed is not a solution to the deeper problems. you're the Euro area doesnt functions very well as an economic and monetary union that we don't have alone. Growth in Europe. We don't have the demographics or innovation or technological improvements. It's gonna drive growth of substantially stronger rights than what we're forecasting so the type of path we outlook is a better python being it's probably sustainable over a period of years, it's probably enough
to avoid the kind of political melt down which would create existential risks again and lead us back into twenty eleven twenty twelve, but what I think we will have to keep in mind that this is not strong enough growth and it's not enough institutional reform, and it's not enough improvement in the performance of the EU either in political terms or economic that is really eating as out of firm of some of them, we been for a long time, and so you know, Europe still has a lot of homework to do. Europe's problems or use problems are not fundamentally to do the UK the problems of Europe and the Euro area need to be addressed by as in the Euro area and in the EU, and maybe the breaks it can act as a catalyst to sort of a forcing mechanism that concentrates, lines, but I'm not sure the it's the source of the problem. If you would have had an easy solutions to the problems facing the Euro area you'd already of implemented, he thank you very much for joining us. Thank you.
and on that quasi optimistic note. That concludes this episode of exchanges of Goldman Sachs objects. You Thanks for listening this spot gases, courted on June twenty seventh, two thousand. Sixteen all price references and market forecasts correspond to the date of this recording. This podcast should not be copied distributed, published or reproduced in whole or in part the information contained in Spock Ass does not constitute research or recommendation from any Goldman Sachs Entity to the listener. Neither Goldman Sachs nor any of its affiliates makes any rep
and or warranty as to the accuracy or completeness of the statements or any information contained in this podcast in any liability, therefore, including in respect of direct indirect or consequential loss or damage, is expressly disclaimed. The views expressed in this podcast, or not necessarily those of Goldman Sachs and Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by Goldman Sachs too. That listener, nor to constitute such person a client of any Goldman Sachs Entity
Transcript generated on 2021-10-14.