UK: Macroeconomic implications of the Leave vote – Goldman Sachs

Research Team at Goldman Sachs, suggests that macroeconomic policy uncertainty is a key channel for the Leave decision to weaken the UK’s growth outlook, with implications for the rest of Europe.

Key Quotes

“Over time, there will be additional, direct macro effects. Most notably, this includes an adverse terms of trade effect as the UK's access to its major export markets is reduced or made more costly. Whether financial conditions tighten, and if so by how much, will also be key and these effects may go beyond what their past link with uncertainty would imply.

We had estimated that the rise in macro uncertainty associated with a Leave decision would reduce UK real GDP by 1-2% over the next 12-18 months, leaving the UK economy flirting with recession. The growth impact on the Euro area would be around -0.5% over the next year. These estimates are sensitive to assumptions about the magnitude of the uncertainty created by the referendum outcome, and the nature and effectiveness of policy responses to it in the UK and the rest of Europe.

Our expectation is therefore that the Leave vote in the referendum will weigh on activity and lead to a downward revision to growth. Through normal trade linkages with the UK and the effects of other policy uncertainties, the wider European outlook is also subject to being downgraded and placed under review.

In addition to facing a weaker macro outlook, we expect Sterling to depreciate sharply. Our FX Strategists estimated that Sterling could weaken sharply, by around 10% (in trade-weighted terms) in a Lehman-type scenario over the coming months, although this too is sensitive to broader financial conditions. Weaker Sterling will push up on the inflation outlook, at least temporarily, as will the adverse terms of trade shock. Relative to that benchmark, Sterling's fall on Friday has not been unduly large.

Tighter financial conditions could add to that weaker outlook, should financial conditions tighten by more than historical links with macro uncertainty would imply, and despite the policy announcements made by the BoE, ECB (and other major central banks). The period of political uncertainty we now anticipate is likely to exacerbate this risk.”