Brexit to curtail euro zone growth, impact hinging on politics

PARIS (Reuters) - International institutions downgraded their outlooks for the euro zone economy on Tuesday following Britain’s shock vote to leave the European Union but said the real impact of Brexit will hinge on how political leaders handle future talks with London.

The outcome of last month’s British referendum has rocked financial markets on the continent, with the threat of a recession in one of the single currency area’s main trading partners increasingly being seen as a certainty.

Leading forecasters from the euro zone’s three biggest economies -- Germany’s Ifo, France’s INSEE and Italy’s ISTAT -- said on Tuesday in a joint note the bloc would start feeling the pinch of Brexit, via lower trade, in the fourth quarter.

They saw euro zone growth slowing to 0.3 percent in the final three months of the year from 0.4 percent in the third quarter, while the outlook for the medium term depended on how fast EU leaders struck a deal with Britain.

“A sharp increase in uncertainty in the management of Brexit and future agreements with the EU could trigger turbulence in the financial markets, reduce confidence and hence put new investment on hold,” they wrote.

The warning came on the day the International Monetary Fund cut its outlook for Italy, long one of Europe’s most sluggish economies, and France, where a recovery has struggled to take hold, by 0.25 percentage points apiece for next year.

The Washington-based IMF said Italy faced “monumental challenges”, as its struggles to close the growth gap with its peers, weighed down by a very high public debt and banks saddled with 360 billion euros of bad loans.

A trader walks past the German DAX Index board on the trading floor at the Frankfurt stock exchange, Germany, June 24, 2016, after Britain voted to leave the European Union in the EU BREXIT referendum. REUTERS/Ralph Orlowski/File Photo

“We are now in the process of revising down our near-term growth projections for the entire euro area,” said IMF assistant director for Europe, Christian Mumssen, on a conference call about France.


“Brexit has brought to the fore the main obstacle to sustainable growth in the euro zone: a definitive clean-up of Italian banks’ balance sheet,” said Frederik Ducrozet, an economist at wealth management firm Pictet in Geneva.

Economists doubted the uncertainty would trigger a new bout of sovereign debt problems similar to the crisis of 2010-2012.

“The problem is financially manageable whatever way you look at it,” Ducrozet said, adding that even if Rome decided to inject funds into its banks, sovereign bond yields were unlikely to spike thanks to the European Central Bank’s bond buying programme.

Supporting that claim, ratings agency Moody’s said EU countries had only limited direct exposure to the UK, although the effect on Ireland, Belgium and Spain could be more significant than for other members.

Showing growth in once-struggling euro zone countries can even surprise on the upside, Ireland reported a 26.3 percent increase in gross domestic product last year.

The dramatic jump from an initial estimate of 7.8 percent follows a sharp revision of the stock of capital assets that some economists said called into question the data’s relevance as a measure of the economy.

And with German inflation still extremely low at 0.2 percent in June, some economists called on Berlin to do more to stimulate demand in the bloc’s largest economy to help the area rebalance and cope with the fallout from Brexit.

“This priceless growth in Germany is a real problem, because it shows the engine is stuttering and it raises pressure on overall euro zone demand,” said Ludovic Subran, an economist with credit insurance group Euler Hermes in Paris.

“Everything would be better if Germany engaged in stimulus, but the ECB is doing it for it.”

Editing by Catherine Evans