Lane warns of Brexit-related volatility as sterling slumps

Central Bank governor Philip Lane has warned of further volatility in financial and currency markets as Brexit negotiations progress.

He also said harder versions of Brexit were likely to result in more substantial reassessments of growth prospects and asset prices here and elsewhere.

The Central Bank last week cut its growth forecast for the Irish economy for 2017 from 4.2 per cent to 3.6 per cent as a result of Brexit, while highlighting increased downside risks associated with Britain’s move to leave the EU.

Speaking at an event on the margins of the IMF’s annual meeting in Washington, Prof Lane described Brexit as a “disruptive event that has adverse implications for both the UK and EU economies”.

“At this point the focus of policymakers has to be on negotiating a new UK-EU settlement that can allow both the UK and EU to prosper over the long run.”

In his address Prof Lane said the recent slide in sterling provided an important stabilising mechanism by which the adverse implications of Brexit for the UK’s terms of trade “were mapped into international relative price adjustment”.

He said it was important to put the recent movement in the sterling-euro exchange rate in context, noting “it partly just unwinds the sustained appreciation of sterling that took place between early 2013 and early 2015”.

Sterling tumbled the most last week since the vote to leave the EU in June as investors speculated the UK government’s approach to Brexit may mean forgoing access to the single market.

While the currency’s weakness has helped cushion the UK economy, the latest slide, which saw sterling breach the 90p barrier against the euro, has added to the pressure on Irish exporters.

Sufficient liquidity

Prof Lane said the Bank of England and other central banks, including the

European Central Bank

, had taken the necessary precautions to ensure that banks would have sufficient liquidity to overcome any short-term disruption from Brexit.

He also noted that European banks were now more resilient as a result of the substantial increase in capital ratios forced on them in the wake of the crash, and this was an important factor in ensuring “an orderly market response to the Brexit news”.

Prof Lane also linked the recent decline in euro area bond yields to beliefs that Brexit might represent a headwind for recovery in the euro area, prolonging the phase of “accommodative monetary policy”.

“In turn, the prospect of slower recovery and ‘lower for longer’ interest rates helps to explain the decline in bank equity values that has occurred post-Brexit.”

Relocation

Prof Lane said it was to be expected that Brexit would result in some relocation of financial activity from the UK to the EU.

However, he said given the increasingly harmonised regulatory environment across the euro zone the locational strategies of firms are more likely to be predicted by traditional concerns such as the availability of skilled labour; suitable office accommodation; quality of public infrastructure; relative cost levels (both wage and non-wage components); national education, legal and tax systems; language and cultural factors; and relative attractiveness in relation to “quality of life” indicators.

Brexit highlighted the new urgency of making progress in relation to the Capital Markets Union agenda. " For central bankers the transition towards the new arrangements has the potential to be a source of volatility and will require continuous monitoring and risk assessment," he said.