There are economic consequences of Brexit for the Euro area too

After looking mostly over the past few days about the likely economic future for the UK post Brexit it is time to widen the perspective and look at the implications more widely in Europe. As it and the UK go through a phase of what Chris Martin and Gwyneth Paltrow described as “consciously uncoupling” there are many implications across Europe. This was on the mind of ECB ( European Central Bank) President Mario Draghi yesterday as he spoke at its summer conference at Sintra Portugal. We do not know if he toasted absent friends as US Federal Reserve Chair Janet Yellen and Bank of England Governor Mark Carney were late withdrawals from summer camp. So no chianti and chat with Mario this summer for them!

Mario wants alignment

The speech was revealing in the fact that whilst it explicitly avoided the word Brexit there was an implicit theme which addressed it. Let me explain.

So we have to think not just about whether our domestic monetary policies are appropriate, but whether they are properly aligned across jurisdictions.

This is quite a shift if you think about it. There was talk of aligning policy around currencies earlier this year but of course we have large economies both explicitly ( Japan) and implicitly ( China and the Euro area) trying to push their currencies lower. If we stay with the Euro area some would argue that the 80 billion Euros a month of QE and an official interest-rate of -0.4% have contributed to its fall. It’s trade-weighted exchange-rate has fallen from 104.5 in April 2014 to 94.43 now with the Brexit impact being around 0.5 of that. Just to explain whilst the Euro has risen against the UK Pound £ it fell against the US Dollar.

Still we do have a fall of the size Mario discussed in 2014.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

So he thinks it has raised inflation by circa 0.5% but you note that he does not mention economic growth here. That is because currency depreciations are very awkward for an economic entity which consistently posts current account surpluses.

The current account of the euro area showed a surplus of €329.5 billion (3.2% of euro area GDP) in 2015

After noting such factors it is hard to avoid the view that the phrase “exporting deflation” applies to the Euro area overall. Other nations and trading blocs may well be not entirely keen on “alignment” after the Euro area has already moved some chess pieces in its favour.


There was a clear attempt by Mario to shift the debate to world issues.

What I am saying here is that the same applies at the global level. We may not need formal coordination of policies. But we can benefit from alignment of policies. What I mean by alignment is a shared diagnosis of the root causes of the challenges that affect us all; and a shared commitment to found our domestic policies on that diagnosis.

There are various problems here as I have just pointed out. How can the Euro fall against the Yen or Yuan whilst they are falling against it for example? In fact Mario Draghi sounds rather like he has borrowed the TARDIS of Dr.Who and jumped back to 2008 to talk to Martin Wolf of the Financial Time and Bank of England Governor Mervyn King ( he wasn’t a Baron back then).

Indeed, to the extent that the environment in which we operate is more affected by the global output gap, and the global savings-investment balance, the speed with which monetary policy can achieve domestic goals inevitably becomes more dependent on others – on the success of authorities in other jurisdictions to also close their domestic output gaps; and on our collective ability to tackle the secular drivers of global saving and investment imbalances.

Is Mario singing along with Lilly Allen “It’s not me it’s you” and “It’s not fair”? Also you may note that he is agreeing with one of my themes which is that the credit crunch provided the coup de grace to “output gap” theories. He would not put it like that but you see it has now failed in countries ( UK for example) and now apparently we are told by default in the Euro area so now we have a world one! Please just think through the implications of that and let me offer just one. How would you possibly ever measure it?

Downbeat forecasts

As ever the more private thoughts meet a leaky vessel and let us hope that unlike in the past hedge funds were not given an “early wire” to this. But Bloomberg have picked up on some details.

Draghi sees cutting Euro GDP by as much as 0.5%, document shows

That is a little vague as there were mentions of three years and others used the word growth as we wait to see if that is total or annual. But there was more to come.

Draghi Warns Brexit Will Lead To “Competitive Devaluations”

I wonder if he managed to say that with a straight face! Also I note that the Brexit purdah did not last long. However there is more.

ECB’s Draghi: Concerned Brexit will lead to competitive devaluations, says its time to address bank vulnerabilities ( @DailyFXTeam )

The latter bit caught my eye as we have been told for the last 8 years or so that the ECB has been on the case of reforming the banks and time and time again we have been told that they are “resilient”, yet vulnerable is apparently the new resilient. Every ECB press conference Mario Draghi speaks about economic reform and each month it is the same groundhog day style statement. This if course comes back to the issue of how you can ever reform banks that know they will be bailed out?

The Italian banks

There is an obvious problem here as resilience morphs into vulnerabilities like the 360 billion Euros of sour loans at the Italian banks. This is a fast-moving situation where it appears that Italy has been informed that an outright bailout breaks the new Euro area banking rules. I am grateful to @liukzilla for pointing out that the vehicle below might be used.


This is 80% owned by the state and seems at first sight to be an effort similar to Portugal where you help the banks but try to keep it off the national debt numbers. For now we seem to be left with the bad bank Atlante which cannot have much more of its 4.25 billion Euros left.  The problem with other banks putting money into it is that they are weakened too and this is similar if not the same to the way that some of the cajas in Spain hit trouble.

Any large-scale move here seems set to blast a hole in the Euro area banking union rules and post questions for the whole concept of it.


So we see one of the reasons for the equity market rally or what is called “risk-on”. There is no explicit “whatever it takes” phrase but Mario Draghi is hinting at yet more asset purchases. So we have a type of Mario “Put Option” for the equity markets. The danger is that he ends up turning fully Japanese and we end up with a Frankfurt Whale competing with the Tokyo Whale. The play King Lear has the image of a little old lady turning the wheel of fortune well each turn of this particular wheel is one more nail in the coffin of the concept of price discovery as instead markets front-run central banks.

Meanwhile we have gone beyond a drum beat and a bass line to a full orchestra playing one of the longest running themes of my work.

Since Thursday, global stock of negative-yielding debt has jumped $1 trillion to just under $11trn, says BAML ( Chris_Whittall )

There is more.

Global 10y sovereign bond yields tumble to record low 0.5826% after Brexit, according to Citi. ( @ReutersJamie )

I still remember going to a UK “think-tank” around 5 years ago and warning about this and noting it hit home. But everybody apart from me then forgot about it.



32 thoughts on “There are economic consequences of Brexit for the Euro area too

  1. Hello Shaun,

    “The decline in bond yields also poses a challenge to the European Central Bank’s quantitative-easing program. Under the ECB’s restrictions, it can’t purchase securities with yields below its deposit rate of minus 0.4 percent. About half of German bonds, which make up the biggest proportion of buying, are now ineligible for purchases,”

    I guess in the end that lower restriction will be removed .

    We’ve had emergency measures since 2008 and QE , none of it seems to be making the economy of the world better or the banks safer, sorry resilliant .

    Seems then we’re back to more QE or helicopter money

    will the EU best first ? I doubt Germany will happy about it


    • Hi Forbin

      You reminded me to recheck the German bond yields as bonds as well as equities have rallied today. Anyway the 2 year is -0.65% and the 5 year -0.56% So both well outside the criteria. Even if the deposit rate was dropped to -0.5% it would only add a year or two to those available. Even the 10 year is -0.13% now!

      As you imply rules keep being twisted and bent. …

  2. Great column as always, Shaun.
    Do you think that the departure of the UK from the EC, should it occur by 2019, will ratchet up the pressure on the remaining Outs in the EC to join the euro area? The UK economy is larger than that of all of the other eight Out countries put together so the relative balance of forces will swing pretty dramatically towards the Ins following Brexit. Also, Croatia and Romania seem likely to join the euro area in 2020; by my calculation the six remaining Out countries would then have only about 15% of the GDP of rump EC. Of these, only Denmark would have the same exemption from joining the euro area that the UK has, and Denmark has been part of ERMII since time out of mind.
    Down the road if the UK or perhaps an independent Scotland ever wanted to re-enter the EU, I doubt very much that either could obtain an exemption on adopting the euro as John Major did in 1992 at the time the Maastricht Treaty was renegotiated.

    • I concur

      If greater unification plans work it will be more than just adopting the Euro that will be demanded

      Further political and financial intergration is required and what they ( the EU ) want is a United States of Europe – anyone joining will be a subjigated state.


    • If, and it is a big, IF Scotland decided to go it alone and re join the EU and consequently the Euro, it would result in significant austerity and cuts as the Scottish budget is not sustainable without the Barnett formula being in place. The last time Scotland voted, oil prices were high and even then the numbers didn’t add up for independence. The Scots are a very savvy lot and (unlike the English) would not buy the politicians false promises. Having said that, nationalism is a powerful force that can easily overcome rational thought.

      • Another big problem for Scotland is that accession to the EU still requires unanimous agreement and Spain has just announced that it would not support it. Fear of Catalan separatism? If Scotland went it alone, why not the Catalans?

        • Spain already has a semi-federal structure, so Scotland (and NI) could go for that and stay inside, especially as free movement is not actually going to change much.

          Cue Brexiters jumping up and down.

    • Hi Andrew, Brexit is likely to increase pressure for reform of a wasteful EU as there is much discontent amongst other EU and EZ countries at the EU/EZ structure. Which way this reform will go is impossible to tell at this juncture.

      The secondary pressure will, as you suggest, be to expand the EZ and the common currency alongside (and probably forming part of EU reform) ongoing tighter political and fiscal integration. Following on from that it will be the case that any “new recruit” or “re-recruit” will likely be required to sign up to the Euro or stay out.

  3. Hi Shaun

    I believe the EU is undemocratic but I think it hugely ironical that in its hubristic, Utopian delusion it could come up with the Euro, a doomsday machine that, in my view, is far more likely to sink the EU project than Brexit.

    If I could guess at one issue which would trigger the demise it would not be Brexit but the subject you have covered on here so often: the Italian banks.

    The Euros40bn proposed is, I understand, illegal under the EU rules. If this plays out according to the rules and the bail in reaches non insured depositors then the firework display will begin. If the banks are bailed out by the state, which is far more likely, it means that the framework which was only devised quite recently is being discarded virtually at its first real test. If this happens it again illustrates the EU as a completely arbitrary entity which has no regard for its own rules. It is indeed “whatever it takes” as Mario Draghi says, even ignoring the rules made five minutes ago.

    The EZ will not only struggle because of its own basic dysfunctionality, it will also be unable to cope with the fact that we are in a new low growth era and this will only serve to hasten the crisis that I believe is quite inevitable. Brexit is a sideshow.

  4. “The FTSE 100 has surged through the level it closed at last Thursday, recovering all of the ground it had lost in the wake of the Brexit vote. ”

    Well that was a bit quicker than I expected

    interesting times


    PS: markets love change , thats how they “make” their money (!!)

    • Forbin they must also love uncertainty as this country is rudderless.
      We have a PM who is an incompetent bully as today’s performance displayed beyond any doubt.We have his most likely successor impersonating Lord Lucan he is obviously terrified of what he has signed up for this was not meant to happen Brexit is his worst nightmare.
      The opposition Leader is suffering some of the worst harrasment and bullying in the workplace imaginable and the narrative is it was his fault.
      There are no free markets all are manipulated by Central Bankers usually ex Goldman Sachs gang members.Banks and trading algorithms are what dictate prices fundamentals do not matter,keep the paper Ponzi scheme going.
      However the debt and derivatives bubble will eventually explode with devastating consequences but they will blame that on Putin ,Corbyn or whoever when it happens.

    • Yes, amazing what happens when much of your company’s earnings are increased by 10% overnight, isn’t it? My Shell shares have done nicely – yet the oil [price in USD has hardly moved!

      If you held a tracker portfolio of FTSE 100, it is worth about the same in UKP, but if you sold it to finance a new house in Spain, it would buy you 10% less. It is a false headline, which also ignores the way other indices unaffected by Brexit have moved.

  5. Hi Shaun, at the moment I don’t think Draghi knows what to do and is wisely playing a “wait and see” game. He’s probably under orders to “say something about Brexit” hence his worthless comments. Unfortunately, due to the fact that the UK Leave establishment does not know what it wants and is yet to establish that valueless collection of hopes and desires, Draghi will have a wait of some months during which time I expect more meaningless speeches from him on this subject, whilst other countries eye the GBP exchange rate nervously. This delay won’t help economies or markets.

    I note the pound increased + 0.87% against the US dollar by close business yesterday with a further .62% gain today at time of typing, so it looks like a rally may be developing although it is best to see what’s happening in 6 months time after the Fed has hiked again. The Ftse 100 has at least regained nearly all it’s lost ground since April and should go on to gain more by year end due to non Brexit related developments last year, although it will be a bumpy ride due to Brexit uncertainty.

    • Hi Noo2

      I am often critical of central bankers but both Carney and Draghi have acted mostly sensibly here. However Vice-President Vitor Constancio is mostly silent at the ECB press conferences for more reasons that it might disturb his afternoon nap.

      (FXMacro )
      “ECB’s Constancio warns of bank deleveraging after Brexit vote “(FT)

      Best to talk and not say much at times like this and as I have argued before in general it is better for central bankers to be in the background. Now more and more people will expect more ECB QE.

      It was quite a surge in the FTSE 100 and if we look wider to the All Share index it is at 3441 compared to 3478 pre Brexit. But my point of earlier this week holds true in that markets will swing around and with Wimbledon tennis being in play Kipling’s treat triumph and disaster the same comes to mind.

  6. Hi Shaun

    Very good as always you mention about the possibility of Super Mario turning Japanese,I have no idea why Japan is not turning Venezuelan how have they got away with these economic policies they are an economic basket case.
    If they can get away with it what would stop Super Mario from doing the same?

    • The average Mr & Mrs Wantanabe are very patriotic doing “all that is necessary” to support the imperial kingdom. Large chunks of Japanese sovereign debt is owned by the public whilst the Bank of Japan owns most of the rest.

      To say “no” is very bad form in Japan so they continue accepting real terms falls in wages etc.

      Europeans aren’t like that, it’s a culture thing.

    • These things take longer than you expect. The Japanese do not stifle domestic food production. Japanese debt is held domestically, Venezuala depends on foreign lenders. The Japanese state is buying shares with funny money, they leave the firm’s management in place and the firms remain productive. Whilst they remain productive there is available wealth for imported food and energy – so this system can limp along for decades

      The Venezualan revolution expropriates private businesses without any compensation and villify the owners and the management as capitalists. After the knowledgable managers are got rid of – production falls, and sometimes ceases completely. Food production has fallen calamitically so has oil production add in oil price falls – and you get a situation where imported food supplies are unaffordable, inadequate and failing.

      Venezuala has implemented price controls. This law will not make sellers sell below cost – this is a market killing law. It causes hunger and worse. A free market is very efficient at sourcing and distributing food as Yevgeny Gaidur proved in the early 1990s.

      • Free markets don’t work. 2007-8 proved that unambiguously and unarguably.
        Had it not been for SOCIALIST intervention in the markets, we’d be eating what we can grow ourselves and grass.
        One law for the rich.

        • No, it was socialist intervention in the money markets by the central banks and a failure to address deficits, which caused the 08 crash. Had we faced up to the consequences in 08, we would not have these ridiculous low rate policies screwing consumption now – which rather proves that we learned nothing from 08.

          The rate drops started in the aftermath of the AQ attacks on the US. Ironically, Bin laden said he would ruin the West economically- he expected war with Islam, but we managed it ourselves.

        • Educate yourself on Venezuala starvation 2016 – everywhere the authorities regulate food prices below cost, the result has been supply chain failure.

          Iceland did not practice “SOCIALIST intervention” for the benefit of very rich bankers. The food supply chain did not break down in Iceland in 2008. QED

  7. Many people don’t care a toss about markets, or GDP or such crap.
    You see, the reason why economic arguments didn’t work against Brexit is very simple; so many of us have been excluded from sharing in any wealth increases that the country makes, as to make it irrelevant.
    We, (and I’m talking about people of my class, rather than personally), don’t give a flying monkey’s if GDP doubles, as we get frozen benefits, zero-hours contracts, forced into self-underemployment and the like, are rent slaves, with no chance of owning our own homes, etc. etc. and see immigration, not as a tool to remedy labour shortages, but as another stick to beat us with.
    There are some of us who actually want to see this venal, corrupt system collapse, and would vote for anything which makes it more likely.

    • Looks like your wish will be granted, although I suspect that the “blame immigrants” line will be increased.

      this ios going to finish up in a complete car crash. The politicians know that they cannot expel or even significantly reduce incoming migrants, as the economy needs them. They know that membership of the SM is vital, because we fail in non-EU markets (compare UK and German trade with China for example). Theresa May has just emphasised the trade in services for the same reason, but the foreign funny money, which underpins it is disappearing while the home grown funny money is now going to see inflation rise, while wages continue to stagnate.

      As they say, careful hat you wish for.

  8. Hi Shaun, a question if I may:
    What effect does Brexit have on the EFSI, you know, Draghi’s wheeze where he starts off with half-a-crown, and ends up with €1trn?

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