Brexit shock will push down already fragile global growth

Brexit, especially if it leads to further political upheavals in the European Union, will be a big setback for global growth


The Markit US Composite PMI Output index for May was the lowest in three months and, although the manufacturing PMI may improve this month; but with the dollar strengthening again as a result of Brexit, that bounce could be short-lived. Photo: Bloomberg
The Markit US Composite PMI Output index for May was the lowest in three months and, although the manufacturing PMI may improve this month; but with the dollar strengthening again as a result of Brexit, that bounce could be short-lived. Photo: Bloomberg

The negative impact of Brexit on the financial markets is likely to be amplified by the worsening state of the global economy. Indeed, the Brexit shock, especially if it leads to further political upheavals in the European Union, will be a big setback for global growth.

Brexit has come at a time when global growth is slowing. Consider the report on the recent consultations between the International Monetary Fund (IMF) and the US. It starts by saying that the US economy “is in good shape”, but then goes ahead and says that US gross domestic product (GDP) growth this year will be 2.2%, slower than last year’s 2.4%. Perhaps more significantly, it’s a climbdown from the 2.4% growth projected in the IMF’s World Economic Outlook published just a couple of months ago.

There are other straws in the wind. The Markit US Composite PMI Output index for May, a survey-based gauge of economic activity in both manufacturing and services, was the lowest in three months and, although the manufacturing purchasing managers’ index is likely to improve this month, that could be because of a weaker dollar. With the dollar strengthening again as a result of Brexit, that bounce could be short-lived.

Experts in the US, too, have been toning down forecasts. The Federal Open Markets Committee, at its meeting this month, had a median projection of 2.2% GDP growth for 2016 and 2% for 2017, compared with the March median projections of 2.2% and 2.1%, respectively.

Nor is the longer-term prognosis very different. The IMF report goes on to deliver a damning indictment of the prospects for the US economy: “A rising share of the US labour force is shifting into retirement, basic infrastructure is crumbling, productivity gains are scanty, and labour markets and businesses appear less adept at reallocating human and physical capital. These growing headwinds are overlaid by pernicious secular trends in income: labor’s share of income is around 5% lower today than it was 15 years ago, the middle class has shrunk to its smallest size in 30 years, the income and wealth distribution are increasingly polarized, and poverty has risen.” Add to that the political risks arising from a possible Donald Trump victory, perhaps encouraged by the Brexit vote.

What about the euro zone, which will certainly be affected by the British exit? The latest flash euro zone Composite PMI, released on the day of the Brexit vote, shows euro zone growth has slipped to its weakest in nearly one-and-a-half years. The first quarter of this year saw good momentum in the EU economy but that is likely to ebb now. Growth in the UK post-Brexit, according to most experts, will be substantially lower.

Japan’s flash manufacturing PMI for June indicates continuing contraction. Earlier, Japan’s PMI indices for May for both manufacturing and services indicated a subdued start for this quarter.

The World Bank, too, has cut its projections for global growth in 2016 by 0.5 percentage point this month. Its projections for the current year are 1.9% for the US, 1.6% for the EU and 0.5% for Japan. And those numbers do not take into account the Brexit impact.

The IMF listed the UK’s potential exit from the EU as one of the seven risks to its outlook. Its World Economic Outlook went on to say, “Materialization of any of these risks could raise the likelihood of other adverse developments. Perceptions of limited policy space to respond to negative shocks, in both advanced and emerging market economies, are exacerbating concerns about these adverse scenarios.” That means global growth projections are likely to be cut further.

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