Leave … Weaker growth and markets

UK Referendum result provokes sharp move from risk-on to risk-off

A significantly weaker growth outlook; central banks focus on maintaining market function
The single-largest macro risk for Europe this year – that the UK would vote to leave the EU – has crystallised. The decision lowers the growth outlook for the UK and Europe amid heightened policy uncertainty and threatens tighter financial conditions. We expect central banks, including the BoE, to stand behind markets and support market functioning. Formally, our European macro forecasts are now under review.

‘Risk-on’ to ‘risk-off’ to drive currencies; Sterling sharply lower
FX volatility is likely to continue. We expect G10 currency moves to mimic a ‘risk-on’ to a ‘risk-off’ pattern, implying Dollar strength as Sterling and the Euro weaken. Further ahead, the risk-reward implies further downside for Sterling in coming days. We expect ‘safe haven’ currencies, such as the Swiss Franc and Japanese Yen, to outperform and the Euro to underperform on UK-focused uncertainty.

Flight to safety to drive ‘core’ European bond yields lower and peripheral bond spreads higher
Markets’ increased conviction that the UK would vote to Remain in the EU, particularly in the last 48 hours, is likely to raise the immediate flight to safety. On past form, the implied scale of an uncertainty shock could lower 10-year Gilt yields to below 1%, in short order. German Bund yields could be depressed further, to -10/15bp, while US Treasury yields could rally to around 1.35%.

Equities across Europe fall, UK domestic stocks most hit
We expect European equities to sell off sharply, particularly following the roughly 8% rally in European indices over the past few days. A further rise in the ERP by an amount typical of previous major risk episodes would lower SXXP to c.280 and SX5E to 2400 – falls of around 19% and 21% in the near term from yesterday’s close. We expect UK domestic equities and the FTSE 250 to be most hit. While central banks will act quickly to maintain market functioning, we judge the likely implications for market pricing to be large, broad-based and rapid.

Goldman Sachs Global Macro Research