ECB’s Constancio Says Tools Available to Handle Brexit Hit

  • Vice president speaks on panel at ECB Forum in Portugal
  • Former BOE’s Bean says split won’t ‘necessarily’ happen

Draghi Avoids Brexit, Calls for Global Policy Alignment

The European Central Bank has the capacity to respond to the fallout from the U.K.’s vote to leave the European Union, though the market impact has so far been relatively contained, Vice President Vitor Constancio said.

“We still have instruments in our toolkit” even if it is “true that we have been using a lot of those,” Constancio said Wednesday on the closing panel of the ECB’s annual forum in Sintra, Portugal. “Markets didn’t freeze. What I see in the markets is totally different from what we saw after Lehman.”

The ECB’s response to the referendum so far has primarily been to remind lenders of existing liquidity channels and currency-swap agreements, as well as pledging to intervene to safeguard financial stability in the 19-nation bloc if needed. President Mario Draghi limited himself to expressing “sadness” on Monday before flying to Brussels the next day, where he told EU leaders that Brexit could cut euro-area economic growth by as much as 0.5 percentage point over three years.

Constancio signaled that the ECB is in no rush to do more. It has a monetary-policy meeting scheduled for July 21, one week after the next Bank of England rate-setting session.

“I think we have to wait a little bit to see where markets go,” he said. “What we see is two days of sudden overshooting in markets. In the last two days there were rebounds and recoveries in all market sectors -- what we see is a certain stabilization.”

Magnified Effect

Global stocks rallied for a second day and the dollar weakened amid speculation policy makers will move to prevent the U.K.’s European secession from hampering global growth.

Constancio said the economic impact on the euro region’s gross domestic product of a Brexit-driven recession in the U.K. would be at first limited to about 0.1 percentage point, given the size of Britain’s trade. That could be magnified by the effect on confidence and the possibility of further political turmoil.

“The impact is what it is, but it can be multiplied by confidence facts in a big way,” he said. “One cannot exclude that, and I’m not excluding that.”

Five days after the shock result of the Brexit referendum, in which 52 percent of voters backed the “Leave” campaign, it is still far from clear how the U.K. will proceed to untangle its four-decade membership of the EU. As the country looks for a new prime minister to act on the vote’s verdict, some observers are even questioning whether the split will actually happen.

Deleveraging Risk

It is “probable” but not “necessarily” the case that the U.K. will trigger Article 50, which starts the formal process to separate from the EU, former BOE policy maker Charles Bean said on the same panel, adding that there is “a very strong moral obligation” to do so.

Constancio said the main source of Brexit-related risk in the euro area is banks, whose shares have slumped since the vote, raising the risk that they’ll resume deleveraging and weaken the recovery in the currency bloc. The ECB’s long-term loans to banks at zero or negative interest rates are a disincentive for that to happen, he said.

“There seems to be quite a mistrust toward banks in Europe in general, although it’s not clear what are the factors that led to a drop of such significant proportion,” Constancio said. “Fundamentals of banks have not changed so dramatically.”

Disunited Kingdom

The vice president cited research presented at the ECB Forum that in the current situation of very low rates and weakening global demand, fiscal policy is the best tool to prop up the world’s economy. Yet he acknowledged that it’s hard to persuade the austerity-minded governments of the industrialized world to do so.

“It seems that fiscal policy is now forbidden everywhere in advanced countries,” he said. “It’s not up to us to address that, but I just quote the best work of academics around this issue.”

As for Bean, he’s left considering what state the plebiscite has left his nation in.

“The effect of the referendum has been to expose divides across the country in many different dimensions,” he said. “My country today is all but united. We should call it Disunited Kingdom at this juncture.”

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