How will Britain weather the Brexit storm? With great difficulty

By: | Updated: June 25, 2016 8:15 AM

Negative implications extend beyond the UK. We see the most downside in GBP and EU equities, and would also be sellers of AUDJPY (target 70), USDJPY (90) and EURCHF (1.02) on a flight to safety. Gilt yields could rally 30-35 bp to all-time lows, but breakeven inflation could ultimately rise, given weaker GBP. In EM FX and local rates, sell Poland and South Africa.

EU-L-reuNegative implications extend beyond the UK. We see the most downside in GBP and EU equities, and would also be sellers of AUDJPY (target 70), USDJPY (90) and EURCHF (1.02) on a flight to safety. (Reuters)

The UK faces a prolonged period of uncertainty which should lead both investment and consumption to wane. Longer term, a less open economy could lower the UK’s rate of potential growth. Risks to the economy will likely lead the Bank of England to keep an easing bias – staying on hold through 2017-18, or a rate cut to 10 bp with further QE depending on exit negotiations.

Negative implications extend beyond the UK. We see the most downside in GBP and EU equities, and would also be sellers of AUDJPY (target 70), USDJPY (90) and EURCHF (1.02) on a flight to safety. Gilt yields could rally 30-35 bp to all-time lows, but breakeven inflation could ultimately rise, given weaker GBP. In EM FX and local rates, sell Poland and South Africa.

ECB support, both potential and existing, argues for buying corporate and sovereign credit into weakness. We discuss levels and our expected central bank response. FX: Poor fundamentals could support 10%+ downside in GBP. Higher global volatility favours JPY and CHF. Increased concerns over eurozone vulnerabilities make PLN the best short in EM.

Also Read: Brexit ravages the rupee; here’s what you should know

We expect significant downside for European stocks – SX5E at 2400-2550 and FTSE 100 at 5000-5300. Financials and Consumer Discretionary will likely lead the market lower, while Staples and Healthcare should outperform.

We expect a strong response from the ECB – we’d add risk in CSPPeligible assets and ‘A’-rated ineligible non-fins on initial weakness. We’d also add bank credit selectively on what we expect will be materially lower prices today – UK banks’ LT2 and AT1s have best asymmetric returns.

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