Uncertainty and lack of confidence expected in markets and economies across Europe as International Monetary Fund says warnings were ignored

The International Monetary Fund has cut its growth outlook for the eurozone on the back of the Brexit vote, warning that a new climate of uncertainty across the single currency bloc will dent confidence, fan financial market volatility and spill over into other economies.

The Fund used a regular healthcheck on the eurozone to warn it would suffer an economic slowdown and more political uncertainty as a result of last month’s referendum result. It is the latest body to warn that fresh cracks could emerge in the region as it grapples with the fallout of the UK’s decision to depart the EU.

GDP in the eurozone is now expected to grow 1.6% this year and just 1.4% in 2017, a slowdown from a 1.7% expansion last year, “mainly due to the negative impact of the UK referendum”, the IMF said. That compares with IMF forecasts before the June vote of 1.7% growth for the eurozone this year and next. The IMF had repeatedly warned before the referendum of dire economic consequences from Brexit, much to the anger of leave campaigners.

In its latest comments, the Washington-based fund highlighted the UK’s importance as a trading partner for the eurozone as the destination for 13% of euro area exports. “The markdowns for the euro area reflect likely weaker investor confidence on account of heightened uncertainty, greater financial market volatility, and lower import demand from the UK.

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“Given the euro area’s substantial weight in world trade, this slowdown would have spillovers to many other economies, including emerging markets but the impact is expected to be limited.

“Looking ahead, the risks to the outlook remain firmly on the downside and are mainly political. Uncertainty will persist as long as the UK’s new status vis-à-vis the EU is not clear. The recommendation in the staff report that collective actions should be taken to improve the governance of the economic union and make it more cohesive remains valid, and has now taken on greater urgency.”



Facebook Twitter Pinterest Old and new IMF forecasts for the eurozone. Illustration: IMF

The UK’s vote to leave the EU heaps fresh pressure on the eurozone project less than a year after debt-ridden Greece came close to tumbling out of the currency union. Grexit was narrowly avoided but the IMF warns prolonged low growth and inflation have left the euro area increasingly vulnerable to shocks. The bloc will also remain prone to recurrent crises of confidence unless political leaders pull together, it says.

Earlier on Friday, a leading credit ratings agency also warned of political shockwaves from Brexit. Moody’s said the UK’s vote could even topple the whole EU project. “In the long run, the potential strengthening of nationalistic and protectionist movements could have a detrimental effect on the EU, even threatening its existence,” it said, in an update to financial markets.

Even before the referendum, the IMF was warning about political tensions in the region and its managing director Christine Lagarde had flagged up risks from economic nationalism and inequality. That theme was reprised in the Fund’s “article 4” annual report into the 19-nation eurozone, written just before the UK’s 23 June referendum. The report was published on Friday alongside a supplementary note with the lower growth outlook written after the referendum.

The IMF’s experts wrote: “Growing political divisions and skepticism have put the euro area at a critical juncture. The usual approach of muddling through appears increasingly untenable, raising the risks of stagnation and further fragmentation.” Downside risks to the eurozone’s growth prospects had increased, amid “growing political divisions and euroscepticism”, the IMF said. Medium-term prospects remained weak, with high public and private debt and slow progress in structural reforms weighing on growth.

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With interest rates in the eurozone already at record lows, the European Central Bank pumping in electronic money and government finances stretched, the IMF warned there was “very little policy space to cope with adverse shocks”. It urged more “collective actions” from governments to strengthen the currency union. Those included “completing the banking union”, in other words unifying financial regulation across the eurozone at a time when Italy is considering using government money to bail out its vulnerable banks.

Governments should also expand centralised sources of investment and prioritise structural reforms that could bolster near-term demand in eurozone economies. On the upside, lower oil prices, a broadly neutral fiscal stance, and accommodative monetary policy were all supporting domestic demand in the eurozone, the IMF said. However, inflation and inflation expectations remained very low, and the ECB should stand ready to do more if the inflation outlook deteriorates further.

It also highlighted risks beyond the UK’s Brexit vote. “Further spillovers from the UK post-referendum situation, the refugee surge, or a heightening of security concerns could contribute to greater uncertainty, hurting growth and hindering progress on policies and reforms,” it said. “Other risks include banking and financial sector weaknesses in some countries.”