11 May 2016

Brexit would mean double blow for CEE: shock then EU break-up threat

If the UK votes to leave the EU in June, its effects will be felt right across Europe and the surrounding region. Volatility and an economic drag are likely — worse would be a fragmenting of Europe

Financial specialists are struggling to quantify how badly the rest of Europe, especially central and eastern Europe, will be hit if UK voters make the shock decision to leave the EU in the June 23 referendum. But the much bigger threat is that a UK exit could shake the European Union so badly that other states start losing faith in it or even leaving.

“If there is a Brexit, it’s a lose-lose choice — both sides will lose,” said Alberto Gallo, head of macro strategies at Algebris Investments in London. “For the UK, because it’s a services economy — it relies on services being located here from Europe.

“For Europe, we are in an environment where the US and China have huge economies of scale and bargaining power. Europe has tried to create some cohesion over the past 40 years, and going backwards is not a good idea.”

A Brexit might fuel rising populist eurosceptic parties around Europe, such as those in Finland, Spain, Austria, France and Hungary.

“I’m estimating the chance of Brexit at 35%,” said Holger Schmieding, chief economist at Berenberg. “In the case of a Brexit, there might be a 40% chance of significant political ramifications that are bad enough to worry about. This is the big danger. Somebody like Austria, the Netherlands or Italy might also have a referendum.”

How the UK’s vote will go is so hard to call that senior policymakers believe the result could be swung even by some unexpected domestic political event, or by how many people turn out to vote.

The insouciance with which many in the UK consider the prospect of Brexit is completely absent from the EBRD’s meetings this week.

Financial experts from all over the continent are taking the risk seriously, and see it as a potential threat for Europe as a whole — even if the direct economic effects may be limited for many countries.

[...]

All agree a Brexit would cause short term volatility in financial and currency markets, which could require central banks to take action. Hans Peter Lankes, acting chief economist of the EBRD, said both the Bank of England and European Central Bank might have to tighten monetary policy if their currencies fell — and that would compel countries further east to do likewise. Others think monetary easing would be a more likely response. [...]

But if the UK left it could have unpredictable results for existing EU members. "There are clearly strains within other EU countries, and it is possible that Eurosceptic parties could demand referenda on continuing EU membership," Hewin said. "That said, if the outcome for the UK is poor, the UK example might be taken as a warning about downside risks of exiting the EU." [...]

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