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Brexit: How it affects the local market

The historic Brexit referendum last week saw Britain vote to leave the European Union, with nearly 52 per cent in favour of the outcome. But what does it mean for Australia?

Brexit sparked global market volatility, sending the British pound plummeting to its lowest point against the US dollar since 1985. The ASX fell by almost 4 per cent the day the result came in. The market reaction was extreme. However, the question now is when balance will be restored and what lasting impacts the fallout could have on the Australian economy.

T. Rowe Price portfolio manager for European equities Dean Tenerelli predicted a protracted period of uncertainty – not only in UK and European financial markets, but also globally.

“Markets do not like uncertainty,” Mr Tenerelli said.

PIMCO’s head of sterling portfolio management, Mike Amey, said the shock of the vote will dominate initial market moves and provide risks in the medium term.

“Near term, the UK economy will be pulled lower by the uncertainty created by the referendum vote,” Mr Amey said.

The initial shock waves of the vote could be clearly seen last Friday, with sharp falls in the British share market and the British pound.

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The Australian share market was down about 3.6 per cent when the ASX closed for the weekend.

Mortgage rates could rise

AMP Capital’s Shane Oliver said the ‘leave’ victory is unlikely to plunge the UK or Europe into an immediate recession and the main impact on Australia will be on financial markets.

“This could affect short-term confidence and may add to the case for the RBA to cut interest rates again, particularly if banks increase their mortgage rates out of cycle due to higher funding costs flowing from an increase in lender caution,” Mr Oliver said.

“That said we expect the RBA to cut rates again anyway.”

ANZ’s Australian Macro Weekly report reflected a similar sentiment.

“Our initial expectation is that the Reserve Bank will be in wait-and-see mode to judge the extent of the volatility, but increased uncertainty will place pressure on the Bank to cut rates if it spills over to consumer and business confidence,” ANZ said.

The report also highlighted that while there may be spillover trade effects, these will be less important given that the UK accounts for only 2.5 per cent of Australia’s exports.

The major bank noted that consumer confidence has recently strengthened despite a spike in uncertainty in May, with confidence rising in early June to its highest level since late 2013.

“This makes us cautious to automatically assume that Brexit will materially affect local sentiment.”

Aussie dollar will fall further

While the Brexit outcome has knocked the Australian dollar lower, it is still higher than it should be, and thus will continue to drop, Mr Oliver said.

“The longer term downtrend looks likely to continue. The Australian dollar is still likely to fall to around $US0.60 in the years ahead,” he predicted.

ANZ highlighted that the Australian dollar’s reaction to global volatility will also shape the Reserve Bank’s decision on interest rates.

Opportunities for Australian investors

T. Rowe Price portfolio manager for European small-cap equities, Ben Griffiths, said that share market volatility is likely to be “broad-based in the short term,” given the lack of clarity regarding what the post-Brexit environment will look like.

“However, even in this environment, there will still be quality companies to be found that are relatively immune to a downturn – those with innovative technologies, leading players in niche markets or those with dominant products or brands,” he said.

Mr Oliver noted the aftermath of the referendum could see “more downside in shares in the short term”.

However, he emphasised that beyond these short-term uncertainties, shares will generally trend higher this year, bolstered by relatively attractive valuations and continuing moderate global economic growth.

He said the key for investors is to look beyond the short-term volatility caused by the Brexit decision or look for the investment opportunities that it produces as investment markets become oversold.

T. Rowe Price Australian equities portfolio manager Randal Jenneke agreed, adding, “the turbulence of the period ahead could also create significant opportunities for bottom-up, fundamental investors”.

What now?

Mr Amey said that following the initial volatility sparked by Brexit, a period of greater relative calm is expected for the medium term due to the fact that Britain’s transition to life outside the EU will take time to negotiate.

“Furthermore, the leadership of that negotiation needs to be resolved,” he said.

“David Cameron has announced he will step down as prime minister by October, meaning that a leadership contest within the Conservative Party will take place over the summer.

“Only after this is settled – and the UK has a new prime minister – will negotiations around the EU separation begin. The time for these negotiations would likely be up to two years, under Article 50 of the Lisbon Treaty.

“In short, these things take time and time can heal what at this moment may seem like a raw wound.”

[Related: Market mayhem as BBC calls Brexit outcome]

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