Apocalypse Delayed in Europe on Brexit Tale of Two Economies

Updated on
  • Index of business, consumer sentiment rebounded in July
  • Fallout greater for U.K., where confidence hits three-year low

The euro-area is shaking off the divorce.

Economic confidence in the 19-nation region unexpectedly rose this month, indicating the immediate impact of Britain’s vote to leave the European Union may be muted. The same may not be true in the U.K. itself, where the European Commission’s sentiment index plunged to a three-year low and two separate reports showed British households fretting about housing and their finances.

While the International Monetary Fund has warned that downside risks to global growth have increased significantly following the Brexit vote, policy makers from around the world haven’t succumbed to that kind of pessimism. European Central Bank President Mario Draghi has said that early estimates of the U.K. referendum’s economic impact need to be taken with a “grain of caution.” New growth and inflation forecasts are due in September.

“The Brexit shock will be worse for the U.K. than many people seem to be thinking,” Adam Posen, a former member of the Bank of England’s Monetary Policy Committee who now leads the Peterson Institute for International Economics, said in an interview. “The impact on the rest of Europe will be less bad. It won’t be very large at all.”

Diminished Risks

In the U.S., gloom about Brexit fallout hasn’t taken hold among policy makers. Less than a week after Draghi’s comments, the Federal Reserve on Wednesday took a step toward raising interest rates later this year, noting that “near-term risks to the economic outlook have diminished.”

The improved euro-area sentiment numbers weren’t the only good news in the region this week. Unemployment fell in Germany and Spain, while Europe’s largest economy also saw business confidence take only a minor dent from the U.K. referendum result.

In Italy, optimism among both consumers and manufacturers improved, which followed a pickup in a business sentiment measure in France just last week.

“On the face of it, a lot of the business surveys look quite resilient up until now,” said Nick Kounis, head of macroeconomic research at ABN Amro NV in Amsterdam. “So far so good, but expectations indicators within a number of surveys have deteriorated more significantly. This could impact the activity measures over time.”

Marked Deterioration

Within the Commission report, euro-area sentiment improved across most sectors in July, with the industry gauge rising to the highest since December. Consumers were less optimistic than in June.

It highlighted the U.K. measure, saying the decline in the overall EU index was mainly due to the “marked deterioration” of sentiment in Britain.

Economists already predict the British economy will fall into a mild recession in the second half of the year, and Clemente De Lucia, an economist at BNP Paribas SA in London, said the euro area will also suffer.

“Euro-zone growth will not be immune to the U.K. decision to leave the EU,” he said in a note to clients. “The impact is likely to resurface over time.”

— With assistance by Andre Tartar, Jill Ward, and Kristian Siedenburg

(Updates with graphic after second paragraph.)
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