By Dominick Stephens, Westpac chief economist
While results are not yet confirmed, it is looking likely that the UK referendum on EU membership will return a "leave" result.
Financial market reaction so far
Global financial markets are shocked - Brexit was considered unlikely before today. The UK pound has fallen 10% against the US dollar, and the euro has fallen 3%. A general "risk off" reaction has resulted, so the New Zealand dollar has fallen 3% against the US dollar. The balance has left the New Zealand dollar up 7% against the UK pound. Share prices in the Asia Pacific region are down 3% (Australia) to 8% (Japan). No doubt the financial market reaction will deepen when European markets open.
Global interest rate markets have reacted by pushing credit spreads wider, while expectations of interest rate hikes from the US Federal Reserve have been pegged back. In New Zealand, pricing has moved decidedly in favour of an OCR cut in August, which seems reasonable at this stage. Markets have also moved to price in some chance of the OCR falling below 2%.
What is next for the UK? If the leave camp is successful in the final count, withdrawal from the EU does not occur immediately. The referendum is not legally binding - exit from the EU will require a Parliamentary vote. After that, the UK has two years to negotiate the exact the details of exit and establish new agreements on the likes of trade. So we face a protracted period of uncertainty around business and trade arrangements in Europe.
Uncertainty while negotiations are completed could result in increased volatility in financial and economic conditions. Furthermore, during the negotiation period the UK would still be bound by existing and new EU legislation, but would lack the ability to influence policy.
What does this mean for NZ?
If Brexit is confirmed, the nervous global environment is likely to see the New Zealand dollar fall further against the US dollar in the days ahead. In time, the uncertainty will also result in higher bank funding costs for New Zealand. This means that although NZ two-year swap rates are falling, mortgage rates and business lending rates are unlikely to fall as far (or may not fall at all).
Financial market nervousness is likely to affect New Zealand business confidence surveys in the near future, although whether that actually translates to hiring and investment decisions remains to be seen.
The Reserve Bank is likely to factor all of this into its thinking on the OCR. Yesterday we regarded the August OCR decision as a close call, but today an August OCR reduction seems much more likely.
What Brexit would mean for NZ exporters is very difficult to say. Suggestions that the UK will now trade more freely with New Zealand seem overconfident and premature to us. Existing trade agreements would remain in place for some time while the UK and EU negotiate the exact nature of exit arrangements. So at least in the immediate aftermath of the vote, NZ’s trading relationships with the UK and the EU will be unaffected.
Beyond this, the nature of NZ trade with the UK and EU would depend on what sort of trade deals we negotiate. However, it’s hard to envision much upside for New Zealand exports to the UK. In the near term, uncertainty is likely to weigh heavily on prospects for the UK economy, potentially dampening NZ exports. And while New Zealand would have the opportunity to negotiate new goods trade agreements with the UK and EU, with a swing toward protectionism in recent times, it’s difficult to see New Zealand being afforded more favourable trade conditions in either jurisdiction. So we will withhold judgement on what this means for New Zealand's merchandise exports.
What we do know is that the UK accounts for a much larger share of New Zealand's tourism sector than it does merchandise exports. The large drop in the UK pound versus the New Zealand dollar, combined with the likelihood of a weaker UK economy, will impact UK tourist arrivals into New Zealand. So for the short-run at least, we regard Brexit as a negative for New Zealand's external sector.
By the numbers
· The UK takes around 3% of New Zealand’s merchandise exports (around $1.7bn). Key exports include sheep meat, wine and produce.
· The UK also accounts for around 9% of New Zealand’s service exports (around $1.5bn). This mainly relates to tourism, with around 90,000 visitors from the UK last year.
· New Zealand purchased around $1.3bn of goods (around 3% of merchandise imports) and $0.9bn of services from the UK last year (around 5% of total services imports). New Zealand’s imports from the UK mainly relate to vehicles and machinery, as well as tourism.