Brexit curveball could upset the central bank status quo

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Image via © European Union 2016 – European Parliament. Press statement on the UK EU referendum with Manfred Weber

Following the surprise decision to leave the EU membership, the latest developments are likely to hit the financial markets hard. At the core of the debate will be the forward guidance from the Federal Reserve which until now looked like another rate hike in August or September was possible. Following the British Prime Minister’s decision to resign, the status quo with the EU remains unchanged for now, but the outcome of the results is likely to have wider and far reaching implications as far as monetary policies are concerned.

It was only in April that the IMF, in its world economic outlook report said that the global economy was growing too slow for too long. The IMF projects a modest 3.20% global economic growth while cutting the US growth forecasts to 2.20%, down from 2.40% previously. The IMF’s bleak projections follow that of the World Bank’s which expects global growth to average 2.40% in 2016, down from 2.90% it forecasted in January this year.

Federal Reserve: While the Fed took its feet off the gas pedal, Janet Yellen was still optimistic of hiking interest rates, albeit gradually. The markets were expecting to see the possibility of a rate hike in August or September (provided the jobs report would return to normal following May’s dismal print). But with the UK deciding to leave the EU, the global markets that are already fragile remain pressured. A Fed rate hike to the current situation is mostly unwelcome at this point in time. Missing the August/September window, the US general elections are due in November, which could indicate that the Fed will likely put on hold its plans for a rate hike, with the possibility of a 25bps rate hike in December. However, between then and now a lot of scenarios could play out which will keep the Fed to tread more cautiously.

The US dollar has been one of the beneficiaries of Brexit as investor flock to the safe haven US dollar. While economic recovery in the US was managed by a weaker US dollar, the current gains in the dollar if consistent could put the economic recovery at risk.

Bank of Japan: For the Bank of Japan, further policy expansion looks to be the only way out. The Bank of Japan, for its part, did make a wise choice not to expand its monetary base at its meeting in June. As expected, the yen has surged along with gold as investors seek safe haven assets. The BoJ is next scheduled to meet in July after Tokyo’s upper house elections are held. Japan’s Prime Minister, Shinzo Abe is also expected to announce further fiscal stimulus spending which could see some kind of coordination between the BoJ and the Japanese government.

[Tweet “The BoE already announced that it is ready to inject 250 million GBP to avert any liquidity crisis”]

European Central Bank: The ECB is likely to remain on the sidelines as far as monetary policy is concerned unless the European markets turn worse. For the moment, the euro is remains pressured to the downside against a stronger US dollar and the impact of the Brexit vote. Further uncertainty is also likely to prevail as Spain heads to elections yet again to break the deadlock over the weekend. For its part, the ECB could limit itself to providing liquidity to the markets, but further policy changes are unlikely at this point in time.

Bank of England: The Bank of England already announced that it is ready to inject 250 million GBP to avert any liquidity crisis. However, in terms of monetary policy, the BoE is more likely to cut interest rates than to hike rates. The full impact of a Brexit is unlikely to be felt in the near term, at least until the Article 50 of the Lisbon treaty is enacted and a full withdrawal starts to take place. Also in question will the newly negotiated treaties with the EU. The departure of PM David Cameron has further clouded the political course of the UK. For the near term, the UK is likely to retain its investment grade rating, but the credit worthiness could be put on a watch list.

There are some initial whispers that the global economy could slip back into a recession. More interestingly, with central banks caught with near zero interest rates, this only leaves scope for more monetary policy easing, or maybe even Helicopter Money.

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