Brexit fallout for New Zealand: sub 2% OCR and uncertainty

The most immediate fallout for New Zealand from the UK's vote to leave the European Union is that the Reserve Bank is now much more likely to cut the official cash rate (OCR) in August and an OCR below 2% is on the cards.

Financial markets are now pricing in a 68% chance the Reserve Bank will cut the OCR to 2% in August.

The head of wealth research at Craigs Investment Partners Mark Lister says financial markets are likely to remain highly volatile but that Friday’s reaction was probably the most dramatic.

“I think we’ve probably seen the most dramatic moves already – I don’t think we will get another day like Friday,” Mr Lister says.

The moves on Friday were exacerbated because financial markets had picked the outcome of the Brexit vote completely wrongly.

The British pound fell to its lowest level since 1985 against the US dollar on Friday and the New Zealand dollar gained nearly 7% against the pound.

Interest rates also plummeted with the US 10-year yield crashing 19 basis points while the New Zealand five-year swap rate sank 18 points to 2.32%.

Share markets were also dramatically affected, with France’s key CAC 40 Index (Cotation Assistée en Continue) shedding 8% after the news, followed closely by the Nikkei 225 Index’s 7.9% drop and the Dax in Germany sinking 6.8%.

In the US, the Nasdaq also fell 4.1% while the broader S&P 500 Index fell 3.6%.

New Zealand’s own Top 50 Index shed 2.3%.

“I think from here uncertainty will hang around for a bit longer and you will have nervousness because people still can’t get their heads around what it exactly means,” Mr Lister says.

“You will see a cautious note prevail and in all likelihood you will see a little bit more downside to equity markets and a bit more volatility across the board,” he says.

For Britain itself, the outlook is grim with its economy taking “a pretty significant hit” in the short term.

Bleak Britain
“There’s every chance they fall into recession, unemployment will probably go up, the pound will continue to languish and go down further and economic activity will suffer, without a doubt,” Mr Lister says.

The European economy will also take a hit and the global economy won’t be immune either, although “I don’t think it will be necessarily enough to drag down the rest of the world or the US,” he says.

“But it will certainly have an impact on global growth. The big question is to what degree.”

And Brexit puts paid to any chance the Federal Reserve will raise rates again this year.

That, and the economic fallout will put even more pressure on the Reserve Bank to cut its OCR in August, with the potential of further cuts after that.

Mr Lister says the trade-weighted index measure of the New Zealand dollar is sitting at 5% higher than the central bank expected it to be at the end of June, “keeping the Reserve Bank quite uncomfortable and that just adds to the list of reasons that they might have to do more than they thought they would have to do three months ago.”

New Zealand’s exposure to the British economy is relatively minor – the country exports about 4.4% of goods and services to Britain and 7.6% to the rest of Europe. Tourism is somewhat larger, with about 13% of total visitor spending coming from British tourists.

The much bigger influences on New Zealand’s economy are Australia, China, Japan and the US.

So the key to how much impact Brexit will have here will be the impact on confidence.

“Confidence is going to be crucial and markets don’t like uncertainty. They don’t like not knowing how things are going to go and all of that will flow through to confidence for businesses, consumers, you name it.”

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