June 28 2016

June 27, 2016 (Commerzbank AG) – The world seems different these days following the Brexit vote and after two days of a sell-off in the global markets. The GBP is at its lowest level in three decades and the safe haven currencies are back in demand. So, what’s next for the major central banks?


At her semi-annual testimony before Congress, Janet Yellen proved very cautious. While remaining optimistic mediumterm, she considers the latest weak jobs growth figure to be no more than a temporary loss of speed. However, the Fed – or at least Yellen – appears to be moving closer to viewing current low growth as a sign of “secular stagnation”. In that case, low productivity gains would be here to stay. Yellen considers the relatively low momentum of investment as a warning signal. In the first quarter, private non-residential investment was 0.5% below the previous year’s level. Therefore, she went on, the equilibrium interest rate was low by historical standards. This is behind the FOMC members’ predictions, which look for a policy rate below 1% by end- 2016 and below 2% by end-2017. Hence, only gradual rate hikes would be expected. Following the “zig” in May – when one FOMC member after another had signalled higher key interest rates – Fed communication has now returned to “zag”.


ECB president Draghi urged euro zone policy makers to support the economic recovery by implementing economic reforms. Draghi’s comments underscore the central bank’s recent message that it has probably done enough for the time being and will now wait to see how its recent policy measures unfold. While Draghi stressed that time is needed for the full pass through of the bank’s measures, at the same time he added that the ECB would act if it saw an unwarranted tightening of financial conditions. ECB Executive Board member Mersch said that he would be the last person to claim that interest rates can be reduced ever further into negative territory. He explained that the ECB wants to prevent “collateral damage for financial market players” and “panic saving”, i.e. people start to save more because they think the period of low rates will last a long time. Draghi emphasised that the judgement of the German Constitutional Court confirmed that the OMT programme is compatible with EU law and falls within the ECB’s mandate. Yves Mersch stressed that the ECB has introduced an issuer limit for the bank’s QE programme as the European Court of Justice “explicitly highlighted” that such limits are needed for the purchases to be compatible with law.

BoE (Bank of England)

With the UK electorate surprisingly voting to leave the EU, and thus wrong-footing the markets, UK asset prices have come under significant selling pressure. The GBP-USD exchange rate at one stage registered a 13% peak-to-trough decline in the space of less than eight hours. Following the plans set out ahead of the referendum and today’s statement (“take all necessary steps”), the BoE will stand ready to inject substantial amounts of liquidity into the market, which will act as the first line of defence prior to any possible rate cut. We do not anticipate at this stage that the collapse in sterling will be uppermost in the BoE’s mind – it makes little sense to stand in the way of a falling knife particularly in view of the fact that this is the most savage move on daily data back to 1971. Far more likely is that the BoE will intervene judiciously only when the time is right (i.e. when it believes it has a chance of achieving the desired effect) in order to nudge the exchange rate. With FX reserves at all-time highs, it has the means to act if desired but there will be no desire to squander them unnecessarily. With regard to rate cuts, the BoE does have this option but having failed to jack them up in 2014 when it had the chance, it is constrained in its choice of actions with Bank Rate effectively at the lower bound.

BoJ (Bank of Japan)

Since the announcement of its extremely expansionary monetary policy (“quantitative and qualitative easing”, QQE) in April 2013, the Bank of Japan has bought government bonds equivalent to around 50% of GDP. It holds roughly 36% of all outstanding Japanese government bonds (JGB) at present and – with the speed of purchases unchanged – is likely to hold around half of all JGBs by the end of 2017. Even the IMF has warned that the BoJ will have to reduce its asset purchases by the end of 2018 to ensure that the government bond market continues to work properly. Even with this aggressive approach, the BoJ has been unable to reach its fundamental goals so far. The plan to drive inflation to 2% by the end of fiscal 2017 (March next year), in particular, appears increasingly illusory. In April, the corresponding measure of inflation – i.e. excluding fresh foods – stood at -0.3%. This is partly due to the significant yen appreciation in recent months which continues to prevent any major inflation pressure from unfolding. The BoJ’s scope for counter-measures appears limited. QE is proving difficult to expand (this also applies to the ETF purchases). Hence, the only “alibi measure” left appears to be a minimal rate cut. The next BoJ meeting will take place in late July.







June 26, 2016 (Commerzbank AG) Brexit – what now?

The UK has voted to leave the EU. We discuss possible implications. Markets already reacted strongly today, but not panicky. They could recover again in the medium term, as in our view an amicable divorce with a continued British membership in the single market is the more likely scenario. We also show that the negative impact on the UK real economy will be smaller than in past crises. Nor will the EU emerge unscathed, because Brexit will encourage parties across the continent which are critical of the EU.

Outlook for the week of 26 June to 1 July 2016

  • Economic data: The ISM index for US manufacturing looks set to have slightly decreased in June, yet staying above 50. In the euro zone, the inflation rate will presumably leave negative territory on a lasting basis in June.

The UK has voted by a surprisingly wide margin to leave the EU. We discuss possible implications. Markets already reacted strongly today, but not panicky. They could recover again in the medium term, as in our view an amicable divorce with a continued British membership in the single market is the more likely scenario. We also show that the negative impact on the UK real economy will be smaller than in past crises. Nor will the
EU emerge unscathed, because Brexit will encourage parties across the continent which are critical of the EU.

Surprisingly clear victory for EU opponents

After a highly emotional campaign, the British electorate voted to leave the EU. According to the official outcome, 51.9% were for Brexit, 48.1% for Remain. Opinion polls did not give a clear picture, but the pound’s rally in recent days indicated that the expected the UK to stay in.

Strong but not panicky market response today

Because the market has been taken by surprise, sterling has already lost considerable ground. The euro and Scandinavian currencies likewise came under pressure. The typical “safe haven” currencies – Yen and Swiss Franc – strengthened. However, the FX market has not yet shifted
into panic mode. EUR-GBP is not markedly higher than it had been in April, EUR-USD is trading above the March levels. The percentage change of sterling does not yet match the scale of the Swiss Franc’s move after the SNB shock on 15 January 2015. Therefore, markets are by non means “disorderly”. Thus, they are not in a state which might bring central banks around to agree on FX interventions. Several G7 central banks are against interventions in any case, be it as a matter of principle or out of self-interest. And those which might contemplate interventions will not pull enough of a punch on their own. Equity markets reacted strongly, but – like the FX markets – not panicky. The Nikkei lost roughly 8%, US futures are currently down around 4%.

Nature of split decisive in medium term

What happens in the medium term after the inevitable market slump today will largely depend on how the UK and the EU part company. According to Article 50 of the EU Treaty, there is a period of two years for the split to be negotiated, and this period can be extended by mutual agreement. The main concern for the UK economy during these negotiations will be to retain access to the EU single market after it has left the EU. The UK could argue that non-EU countries such as Norway, Iceland and Liechtenstein are also given this access, although the UK would then have to accept the rules of the single market (including free movement of labour) and would also have to pay contributions to the EU budget. Before the referendum, the EU view was that if the UK left the EU, it could not stay in the single market, as a deterrent to possible copy-cats. However, in our view the EU still has a strong interest in a clean break:

Exports to UK important:

47% of British exports go to the rest of the EU, whereas only 7% of Continental EU exports go to the UK. The UK is thus still the EU’s number two trade partner, after the US and ahead of China (see chart 1). The EU therefore has a strong interest in avoiding duties on goods traded with the UK and keeping it in the single market. Such duties would after all seriously disrupt cross-border production chains established over
a period of decades. In addition, EU companies would have to prove that their products complied with UK standards.

Avoiding market turbulence:

If the divorce proves acrimonious, we could see upsets on the financial markets. The EU could limit the fall-out if it signalled willingness to reach an amicable agreement.

Its own image:

The EU has a major image problem. More and more voters regard it as undemocratic. If it plays the jilted bride after Brexit and refuses the UK access to the single market, it wouldn’t only be EU critics who would object to that the UK’s democratic decision has been respected. And this is something the EU really can’t afford. If signs of a clean break gradually emerge, sterling and the equity markets should recover again in the medium term.