Our German market analyst, Jochen Stanzl, gives us his thoughts on Brexit and its potential impact on the wider economy.
What do you think the impact of Brexit will be on the UK economy?
I think we need to differentiate between a ‘hard’ Brexit and a ‘soft’ Brexit. Currently, businesses are faced with the challenge of not knowing what the outcome will be if Theresa May fails with her attempt to bring a soft Brexit solution through Parliament. Some businesses are preparing for the worst, some aren’t preparing at all, ignoring the dangers a no-deal Brexit might impose on their bottom lines. Clearly it would be a logistical nightmare to have additional border controls on imports coming into the UK from the EU, potentially delaying all sorts of goods like food, and even critical goods like medicine. A no-deal Brexit could be highly disruptive for the UK economy, while a soft Brexit at least gives businesses the time to adapt to the new situation. The long-term effects of Brexit depend on what new role the UK economy finds in the global economy and outside the EU trade union.
Do you think Brexit will have an impact on EU economies?
It’s important that Brussels defends its core rules. Giving the UK unlimited access to the trade union outside of the EU would render it almost meaningless in many regards. The EU model can only work when there is no ‘cherry picking’ or special treatment for any single member state. This fact applies to Italy’s ambitions to violate the Maastricht debt ceilings with their 2019 budget plans, and also to the UK’s ambitions to stay within the trade union even though they will be outside of the EU. It will be highly important for the EU to secure its integrity in the Brexit process.
Having said that, I also expect a no-deal Brexit to be highly detrimental for business in the EU, as they would be forced to make decisions in a turbulent environment. This increases the chance for abrupt decisions, which might not be the best ones in retrospect. In my opinion, it is always better to work together and cooperate. What is right on a personal level is also right for the interaction between states. Depending on how Brexit plays out frictions could bring down growth, and as we’re already in the late stage of an economic upturn, these frictions could accelerate the next downturn.
What do you think the eurozone might look like in five years?
The eurozone has been tested repeatedly over the past two decades of its existence. The fact of the matter is that it has provided stability during periods of uncertainty, even though it hasn’t always been easy. There are now many measures to safeguard the eurozone against future financial stress, and you can see in BIS statistics that the Euro is gaining importance in world trade relative to the US dollar. I am a little concerned that the exit from lax monetary policy will not be easy for the European Central Bank (ECB) in 2019. The potential of a ‘lower rates for longer’ scenario – as in Japan – is a real one, especially given weak demographics and a wide spread of economic strength across member states. I think given the latest frustrations over Brexit, and the lack of success from pledges made by populist political parties in the past years, there is one standout message: there are no quick fixes and it is not as easy as those populist movements and parties made people believe it would be. My personal hope is that the wave of populist political threats might have run its course, so I’m optimistic for the eurozone.
Which markets do you think will be most heavily impacted by Brexit?
The scenario of a no-deal Brexit isn’t something the markets have seen yet. Any time there is uncertainty in the markets, volatility spikes, and this is also likely to happen with Brexit. A no-deal Brexit will throw the world economy into a situation where no one will know what comes next. It is possible traders would want to sell what they have in their portfolios and hedge in correlated assets, so there could be toxic effects in many areas of the financial markets, as many assets are correlated to each other. I find it unsurprising that the ECB said that they are prepared for such a scenario. Central banks will be in demand to secure liquidity and to make sure that banks will be able to find prices for their assets. This could be a real event risk traders might need to watch.
Which sectors do you think will be most affected by Brexit?
Asset wise, I would expect Gold and the US dollar to profit as safe havens in the event of a hard Brexit, and to a lesser extent in the event of a soft Brexit. Any risk assets would be trading under a higher volatility regimen. Airbus, BMW and any other companies dependent on just-in-time delivery of goods to their factories in the UK and the EU, could be hit hard.
Do you think Brexit will impact house prices?
Just next to our CMC Markets’ office in Frankfurt they are building the largest office and living tower in the city, two stories of which have already been rented by a big international bank, who are moving most of their staff from London to here. They’ve rented the office space even before the skyscraper is finished. When I talk to realtors in Frankfurt, they all expect that due to Brexit there will be more demand for rental apartments (especially for ready-furnished ones) which can be directly rented by British companies that need to move at least parts of their business here. There is a lot of demand potentially moving to Frankfurt, and the market is definitely preparing for it. When it comes to housing prices in Germany they have risen over the past ten years, but they have also been stagnant in the previous decades. Compared to London, prices in Frankfurt are still cheap. In the end, Brexit could have a positive effect on house prices in Frankfurt, but you cannot count on this effect alone when buying a house in the area. Prices will be most influenced by other factors, such as what insurers do with their holdings, or where the ECB will go to with their monetary policy next.
How do you think Brexit will impact the financial sector?
Brexit is seen as an opportunity for the financial sector in Germany, as many international banks will need to move at least some of their business here to comply with regulatory requirements going forward. Although I doubt whether it will be enough to just impose regulatory requirements on the financial sector, in order to brighten the future for the sector as a whole. More will need to be done to make the EU an attractive market place for the financial sector. I think there will be forced adaptions by the financial sector, which is trying to maintain its current business situation, but any future expansion plans will not necessarily be based on Brexit. In the financial sector, money can move fast from one place of the world to another. This is very different to a company like Airbus for example, who employ hundreds of highly skilled people in one factory in order to build aeroplane parts. Should Airbus move its factory, employees would find it difficult to find other jobs in the area. I don’t think this would be as much of an issue for financial specialists in Frankfurt or London; they will continue to be able to find jobs where they live. There is a stark differentiation to be made when looking at the impacts on the financial sector relative to other brick-and-mortar sectors.
How could Brexit affect interest rates?
We are in a late economic upcycle and there could be a recession coming in late 2019 , but it might be here earlier if the fallout from Brexit is a strong one. I am a bit worried about whether it’s reasonable for the ECB to expect to hike rates in an economic environment which is already in a downturn. By doing so, the ECB could risk steepening a recession later on. As time passes it looks less probable that the ECB will be able to exit from easy monetary policy at all, and Brexit won’t help here.
How could the pound react to Brexit?
Traders must be aware that a no-deal Brexit is a scenario markets haven’t fully priced in yet. Markets expect that there will be some sort of arrangement coming, or even the possibility of another referendum which could lead to no Brexit after all. Traders need to prepare for a no-deal Brexit (the not-priced-in scenario) which is similar to preparation for any major news event: find real support and resistance lines and make a plan. For example, how do you trade the volatility if news of a no-deal Brexit comes out? Which tested trading strategy could you apply in such a scenario? Which resistance lines could come in play, and which supports? A trader could also look at the reaction of the pound to the Brexit referendum. Traders need to be prepared before the news announcements and should prepare for what to do when the markets react in a certain way. You can never know exactly how they will react, but you can predict when there will be volatility. Having said that, there is already a lot of volatility on GBP currency pairs, so traders are already able to take advantage of this situation in their daily trading.
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