Brexit. What’s Next?

Brexit FBWhat a day in the markets. Britain surprised the world and walked out on the European Union.

In response, markets crashed around the globe—sovereign bonds aside.

Here’s a quick rundown of the Canadian implications…

It’s Not the End for the UK/EU

UK’s parliament must still vote to exit the union, albeit that’s expected to be a formality. Britain must then remain in the EU for two more years, and it’s not impossible for the country to change its mind in that time. Barring that, there’s the possibility that the EU and UK negotiate an alternative trade deal. After all, roughly half of UK trade is with the European bloc.

More Accommodative Central Banks

The UK’s Treasury expects its GDP to be a whopping 3.6% lower in two years. Economic fallout and uncertainty (including uncertainty about who might leave the EU next) will curb foreign investment and slow monetary tightening worldwide. That includes in the U.S. where rate hikes are now improbable for much longer. At the very least, “This dramatically lowers the probability of a hike this year,” said TD earlier.

Canada’s Bonds More Appealing

A more dovish Fed, the downgrade in Britain’s credit rating and economic aftershocks all give Canadian bond yields more leash to run—lower, that is.

But mortgage rates are likely not about to fall off a cliff near-term. Canada’s inflation outlook will be more greatly impacted by things like negative sentiment and falling oil than any deterioration of UK trade. And those rate drivers could take time to play out.

As for specific numbers, “The economic ramifications for Canada are challenging to estimate,” says Bank of America Merrill Lynch, “…For now we have trimmed 2017 GDP growth by 0.2 percentage points to 1.7%.”

Mortgage Rate Path Altered Slightly

There’s a possibility we could see higher risk/liquidity premiums built into mortgage rates, especially variable rates. But make no mistake, there’s nothing long-term bullish for rates in this news.

For us to see any material fixed rate cuts, the 5-year yield will need to drop closer to its all-time low of 0.40%, or below.

As for the prime rate, Brexit talk will surely inspire more economists to push rate-hike projections into 2018. At the moment, OIS prices imply a 1 in 3 chance we’ll see a BoC cut this year.

More Fuel for Canadian Real Estate?

UK instability could boost international demand for Canadian housing, believes Mortgage Professionals Canada CEO Paul Taylor. “…The uncertainty it causes in the European marketplace now only exacerbates the Toronto and Vancouver foreign investment elements of the overheating housing market.”

A cheaper loonie could add even more fuel to that fire.

“Hopefully policy-makers will move quickly to address this issue and not delay for the full StatsCan study to be completed,” he says. “I fear at that point it may be too late.”