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Emerging Europe emerges from Brexit’s wake

Although Emerging Europe was undoubtedly the most significantly affected region after the Brexit vote result sent out shockwaves globally, the region’s bond and currency markets recovered quickly.

Jun 29, 2016 // 4:14PM

The IIF, in a recent report on the impact of Brexit on Emerging Europe, noted that growth will likely slow across the region due to fewer exports to the UK.

The report stated that as a result of slower economic growth, there would be an easing of central bank policy across the region.

However, Jan Dehn, Head of Research at Ashmore said it is unlikely central banks across Emerging Europe would be required to make major policy changes in the wake of Brexit.

Part of the reason is that the UK has relatively small trade ties with Emerging Europe. Poland, one of the largest exporters to the UK from Emerging Europe, only sends just over 6% of its exports to the UK, which makes up around 3% of the country’s GDP according to figures from the IIF.

“The UK is a small European country and the fundamental impact on EMs is small. EM markets have rightly not been too bothered with Brexit and central banks are likely to keep their focus on growth and inflation dynamics, as they should.”

The risks to short-term financing would also likely be small. Although foreign banks contribute 63.2% of GDP in Poland, British banks only contribute 1.4%, figures from the IIF show.

Furthermore, many EMs have already experienced financial tightening over several years due to a large portfolio shift out of EMs into developed markets, Dehn noted.

“Institutional investors jumped on the DM central bank QE band wagon.”

Although Emerging European currencies experienced volatility in the wake of Brexit, weakening from between 2% and 6% against the US dollar the day after the vote, they have remained relatively stable against the euro.

“The Brexit situation is likely to play out slowly. The impact on the Eurozone will be minimal, and it is the euro currency pairs that matter for Eastern European currencies rather than the pound.”

Dehn added that if there were to be any impact on the euro, it would mainly be felt in the Czech koruna, the Polish zloty and the Hungarian forint.

The bond markets across the Emerging European space have also, after some initial shocks, recovered quickly.

Figures from the IIF show that although Poland’s 10-year bond yields jumped by over 20bp on June 24, they have since fallen and have settled around 6bp over what they were before the vote.

“Bonds across EMEA have rallied strongly, with major upticks in Poland, Hungary and the Czech Republic. Turkey and Russia – often regarded as higher beta trades – have also rallied.”

Turkish 10-year bonds rose by around 50bp on June 24, but have since fallen back to below their pre-Brexit levels by around 2bp.

The return to relative stability makes EMs a competitive buy, especially compared to their DM counterparts. “EM is cheaper and safer than developed markets by a long mile,” Dehn noted.

Europe Macro Currencies

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