August 2, 2017    5 minute read

What You Need To Know About the Impact of Brexit on the EU

Aftershocks    August 2, 2017    5 minute read

What You Need To Know About the Impact of Brexit on the EU

According to the second quarter figure, the Euro Area’s GDP increased by 0.6%, following the 0.5% rise at the beginning of the year. Euro Area economic sentiment also rose to a decade-high of 111.2 in July on the back of increased optimism in services and construction, while confidence in industry remained at its highest level in more than 6 years.

Among the 19 members in the bloc, Spain and Austria were the ones with the strongest performance. The Spanish economy expanded by 0.9%, the fastest since 2015, while the Austrian by 0.9%, which is its best performance in more than six years. The strong performance in these countries will undoubtedly have a positive impact on Euro Area employment and growth, causing inflationary expectations, which would be warmly welcomed by the bloc struggling with inflation below its goal, residing at 1.3% in July.

Policy makers are optimistic that a stronger labour market and closing output gap will lead to inflationary pressure. “The current positive cyclical momentum increases the chances of a stronger than expected economic upswing,”, according to ECB President Mario Draghi. Nonetheless, revising QE, a decision expected in the autumn might be too soon, even though the area is growing steadily.

Brexit and the Euro Area

The impending Brexit and the consequences UK’s departure will hinder economic activity in the entire bloc, with different intensities. Of the two countries that contributed most to the second quarter performance, Spain’s impact, going forward, will be much more pronounced, due to the stronger economic ties it enjoys with the UK. Austria, on the other hand, might have a marginal effect on the performance of the area, in light of Brexit.

Brexit Slashes €4bn of Spanish GDP

Earlier in March this year, a leaked report of the Spanish government warned that Brexit will hurt the Spanish economy, leading to €2 to 4bn in GDP decline, due to the strong economic ties between the two countries. The industries that would be hit hardest are tourism and food, pharmaceuticals and automotive. Exports could decline within the range of €500m to 1bn. Moreover, renowned Spanish companies with significant UK exposure, such as Banco Santander, Telefónica and Iberdrola, would be at threat from currency fluctuations.

In addition, despite the impressive recovery, Spain is still facing very high levels of youth unemployment of approximately 39%, wages have remained depressed or have diminished and there is jobs insecurity due to frequent strikes and labour negotiations. The manufacturing sector that contributes most to higher output, is significantly lagging in terms of productivity in the EU.

Technology to the Rescue

Fortunately, Spain has a rapidly developing productive technological sector. Having the 5th most important technological hub in the EU makes it well suited to continue developing competitive businesses, eventually employing the youth and raising wages. Conditional on appropriate regulation and investment, Spain is also well positioned to take over British fintech jobs and additionally strengthen its long term growth prospects.

Banco Santander is already the most active European bank investing in financial technology, but its Santander InnoVentures is located in London, where it can easily identify aspiring and lucrative fintech start-ups. Provided proper regulation is enacted in Spain, Banco Santander could use its network and knowledge to help develop the Spanish fintech sector and eventually contribute to Euro Area employment.

Limited Effect on Austria

Uncertainties arising from effects that cannot be precisely quantified at present and are dependent on new trade relations and migration regulation will have a negative impact on Austrian business confidence. Investment might be hindered by exit negotiations and elevated global uncertainty, including US protectionism, global terrorism and political turmoil in the Middle East.

According to the OECD, Brexit could cause real GDP loss of 0.5% by 2020. Another study, conducted by the Ifo Institute of Economic Research and Bertelsmann Stiftung, estimates that by 2030, the Austrian real GDP p.c. could decline by 0.05% in the case of “soft Brexit” or 0.18% in the case of “UK isolation”.

However, it is difficult to provide more precise and detailed quantifiable estimates of the effects, due to the lack of publicly available analysis. At present, any ex-ante (model-based) quantification will include very limited information, while simulations will have to be based on more or less plausible scenarios regarding future relations between UK and the EU.

Moving to Vienna?

The effect on trade will be limited, but nevertheless negative. Brexit might not hurt Austrian exports significantly, due to its involvement in the value chains of other EU members and the possibility to export to these countries. Austrian trade, like the Spanish, will be affected by currency fluctuations.

Given UK’s net contributor position, Austria’s contribution to the EU budget will have to increase, while the EU financing it receives from CAP and EU Research funds will decrease.

Austria and the UK could develop a special relationship, arising from future institutional relocations. The European Banking Authority (EBA) and European Medicines Agency (EMA), both currently located in London, intend to relocate to Vienna. The city might also become an attractive location for some London banks, after losing “EU passport”, as well as for the HQs of British insurance and other companies.

Cautionary Note

The strong performance in these countries has already externalized into the growth of the Euro Area and is likely expected to cause inflationary expectations and Euro appreciation. However, given the existing threats arising internally and caused externally by Brexit, and considering the significance of these economies, especially the Spanish, the recent performance influencing future forecasts should be taken with a dose of caution.

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