Eurozone: Weighing up Brexit related risk - MUFG

Lee Hardman, Currency Analyst at MUFG, suggests that the initial Brexit vote fall out has resulted in the euro weakening more modestly as well.

Key Quotes

“The main drivers of euro weakness are increased concern over political stability in the euro-zone, the health of European banks, and the outlook for the euro-zone economy. The Europe Stoxx 600 banks equity index has fallen back towards the lows recorded during the peak of the euro-zone sovereign debt crisis.

Comments from ECB officials so far have signalled that they are not overly concerned by the negative impact on the performance of the euro-zone economy. Bloomberg reported earlier this week that ECB President Draghi told EU Leaders that euro-zone growth could decrease modestly by as much as 0.5% for the next three years after the UK referendum outcome.

ECB Vice President Constancio displayed a cautious tone yesterday stating that the impact on the euro-zone economy of a Brexit-driven recession in the UK would at first be limited to about 0.1 percentage point. However, he stated that could be multiplied by the effect on confidence and the possibility of further political turmoil. He also believes that the main source of Brexit-related risk in the euro-zone is the banks.

We expect the ECB to ease monetary policy further in response to the negative shock to the euro-zone economy given that the inflation outlook is already uncomfortably low. Announcing an extension to the QE programme which is currently due to expire in March of next year is one obvious policy option. However, the ECB does not appear to be in an immediate rush to announce further easing. ECB Vice President Constancio stated that “I think we will have to wait a little bit to see where markets go”. We doubt that further ECB easing would materially weaken the euro given that it appears to be having a diminishing negative impact.

EU Leaders sent a strong signal to the UK government yesterday stating clearly that “access to the single market requires acceptance of all four freedoms” which are the free movement of capital, labour, services, and goods. It follows a similarly strong message from Prime Minister Cameron to EU leaders that they would have to accept that British voters could not accept the free movement of workers as an entry price.”