Political tensions in Europe are flaring up again—this time over Brexit.
As shown in the LPL Chart of the Day, the British pound and the euro both dropped to the lowest levels since June 2017 after the U.K. government agreed last week on a proposed plan for the country to leave the European Union (EU). The EU-imposed deadline for the exit, or Brexit, is March 2019.
“Currency traders are bracing for a rocky evaluation process as both Parliament and the EU Council weigh in over the next month,” said LPL Chief Investment Strategist John Lynch. “Even though the U.K. is a small portion of the global economy, any outcome from this point complicates the macroeconomic environment worldwide.”
A hard Brexit, or the U.K. leaving the EU without the two parties reaching a deal, appears to be the worst-case scenario for U.K. and European economies. EU economies are still struggling with fiscal issues and tepid growth, even amid quantitative easing and structural reform. A no-deal Brexit would pose a swath of challenges in figuring out details of the arrangement, while a negotiated Brexit will likely have fewer unintended consequences. However, an easy path to Brexit may encourage other EU nations to follow suit. The EU is in a tough position right now, as it is trying to minimize economic disruption, while sending a message to other countries that an EU exit would be a difficult process. We see a hard Brexit as unlikely, as that outcome is not in anyone’s interest.
Markets are also watching the Brexit outcome for its potential impact on other populist movements. Successful pushback against British Prime Minister Theresa May’s compromise proposal may embolden populist movements elsewhere, although any subsequent adverse economic fallout would ultimately render the verdict negative.
On the surface, hiccups in the U.K.’s economy would have a negligible impact on global output, considering the U.K. comprises only 4% of global gross domestic product. However, global growth has been inconsistent at best in this post-financial crisis era, and any disruption to economic progress could be problematic. The U.K’s exit from the EU could also negatively impact global corporations as they adjust to new standards and rules.
Overall, recent Brexit developments haven’t changed our views. We remain cautious on Europe’s growth potential given political turmoil and tenuous economic conditions.
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