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Update on Brexit: What’s Next for Britain and the EU?

The UK’s vote to leave the European Union could have broad repercussions for Britain’s and Europe’s futures

WHEN THE BRITISH VOTED in June 2016 to leave the European Union (EU) after more than four decades of membership, jaws across the globe dropped in surprise. Most polls in the United Kingdom had indicated strong support to stay, yet 52 percent of voters elected to leave. In response, pro-EU Prime Minister David Cameron resigned, the British pound plunged to lows not seen in 30 years and populist movements in other EU nations stood up and said, in effect, “We’re next.”

Here, Christopher Hyzy, chief investment officer at Bank of America Global Wealth & Investment Management, and Karin Kimbrough, head of Investment Strategy at Merrill Lynch Wealth Management, shed light on the significance of Brexit and what investors should watch for next.

Britain’s surprise vote, the rise of “leave” campaigns elsewhere in the EU and the election of Donald Trump all seem connected. What’s going on?

Chris Hyzy: There is a rising populism around the world that probably got its start in 2011 with the Arab Spring —ordinary people protesting their governments for perceived unresponsiveness. In fact, in the U.S., you can trace it back even earlier, to 2008, at least. After the market crashed, the Federal Reserve initiated a series of quantitative easing programs that helped troubled areas of the U.S. economy to recover. But the lack of attractive nominal growth that followed may have left some segments of the population — those facing persistent income inequality — feeling like they were being left behind. And in the 2016 presidential election we saw what amounted to voter backlash.

What are Britain’s next steps?

Karin Kimbrough: The next key step at this time is for Prime Minister Theresa May to invoke Article 50 of the Lisbon Treaty, the EU’s legal mechanism for withdrawal, which once triggered, requires exit within two years. That could feasibly push Brexit to 2019 — later than initially expected. This February the British Parliament—as required by the UK’s High Court—voted overwhelmingly in favor of starting the exit process, moving Britain a step closer to separation.

"Initial expectations were that the Brexit vote would be negative for the UK economy, but so far there is little evidence of that."—Karin Kimbrough,Head of Investment Strategy, Merrill Lynch Wealth Management

How is the British economy faring in the aftermath of the Brexit vote?

Ms. Kimbrough: Initial expectations were that it would be negative for the UK economy, but so far there is little evidence of that. The Bank of England stepped in with a stimulus package, including an interest rate cut, which seemed to help. Near-term, economic data — retail sales, the labor market, and so forth — has, if anything, shown improvement. That said, many economists think the economy will slow somewhat in the long term.

Mr. Hyzy: Given how exposed the UK is to the EU in terms of trade, the British government will likely have to renegotiate many trade agreements, not only with the EU but also with other nations.

 

How is the EU government responding?

Ms. Kimbrough: The UK seems formally opposed to some elements of membership but not others, and may be hoping to “cherry pick.” It might like to keep borders open for trade, for instance, but not for people. But EU lawmakers are basically saying, “It’s all or nothing, no cherry picking allowed.” This is often expressed as a “soft exit” versus a “hard exit” and we believe that ultimately it will be the latter.

Elsewhere in Europe, populist anti-EU movements are on the rise. Could we see other member countries attempt to leave?

Ms. Kimbrough: That’s not entirely clear. In an early December 2016 vote, Austria rejected far-right presidential candidate Norbert Hofer. But in the same week, Italian voters blocked constitutional amendments in what many viewed as a win for “Eurosceptic” populist parties. Meanwhile, Marine Le Pen, leader of France’s far-right National Front party and a likely frontrunner in this year’s presidential election, seems emboldened by the Trump win.

"Given how exposed the UK is to the European Union in terms of trade, the British government will likely have to renegotiate many trade agreements."—Christopher Hyzy,Chief Investment Officer, Bank of America Global Wealth & Investment Management

How has the Euro—the EU’s single currency—been doing in all of this?

Mr. Hyzy: The Euro has weakened versus the dollar since Brexit and could be seriously tested by upcoming elections — and a further rise in populism and protectionism — in France, Germany and elsewhere.

What could Brexit mean for U.S. corporations?

Mr. Hyzy: In industries such as finance, healthcare and energy, many companies have invested billions of dollars in the UK over the decades on the premise that it would remain in the EU; indeed some have used the UK as their EU entry point. Now, many may wonder if this commitment is still worthwhile. It’s a question U.S. investors need to keep in mind looking ahead. Any delay in initiating Article 50 may help in the short term.

3 Questions to Ask Your Advisor

  1. Could U.S. companies be helped or hurt by Britain’s exit from the EU?
  2. What sectors of the economy could benefit from a stronger U.S. dollar?
  3. Should I make any adjustments to my portfolio in light of these developments?

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