By Georgi Kantchev 

The reaction of economists to Britain's vote to leave the European Union has been swift and brutal as they slash forecasts for growth across the world, triggering a round of follow-on market downgrades from banks' analysts.

The U.K.'s decision to exit the EU in a June 23 referendum rattled currency, bond and equity markets, pushing the pound to a 31-year low earlier this week. While markets have since stabilized, analysts are now looking at the longer-term consequences of prolonged turmoil in the world's fifth-largest economy.

"Brexit could potentially derail a still fragile recovery and push us toward a downturn," economists at Morgan Stanley said in a report this week. The bank raised its estimate for the probability of a global recession in the next year from 30% to 40%.

While analysts say the direct effect beyond Europe's shores is smaller, reduced growth on the continent is bound to affect global trade as well as multinational companies, many of which count Europe as one of their key markets. The stronger U.S. dollar is also expected to reverberate across the globe, hitting profits of U.S. companies and emerging markets.

The Brexit jitters come as global trade has already been weakening in recent years, rising by just 2.8% in 2015, according to the World Trade Organization, the fourth consecutive year below 3% growth.

Brexit is "the most significant pull back to-date from the post-World War II consensus of closer integration and open trade," analysts at Credit Suisse wrote in a report titled "The End of Globalization." "Such a significant secular shift has the potential to have substantial negative implications for growth, corporate profits and asset prices in the medium term."

The U.K. bears the brunt of the forecast cuts, with some banks forecasting that political uncertainty and a fall in investment herald a recession later this year. With Britain's political situation in flux and its exit negotiations with the EU likely to drag on for years, analysts see a long period of weakness for the pound. That, in turn would boost inflation and further curb consumer spending, economists say.

"The U.K. will quickly fall into a recession and the longer we have this political uncertainty, the worse it is going to get," said Rob Wood, an economist at Bank of America Merrill Lynch. The bank expects a recession from the third quarter until the beginning of next year and has cut its forecast for U.K. economic growth in 2017 to 0.2% from 2.3%.

Across the English Channel, the most immediate Brexit-related disruption could come in the form of lower U.K. demand. Britain is the largest source of demand for eurozone goods and services, accounting for 13% of total exports, according to HSBC. After the Brexit vote, the bank cut its forecast for the eurozone's gross domestic product growth in 2017 to 1.0% from 1.5%.

Citigroup expects countries with the largest U.K. trade exposure like Germany, Belgium and the Netherlands to be the most affected.

"Brexit is a material economic shock to Europe," said Joseph Lupton, senior global economist at J.P. Morgan. "This will delay the economic recovery there and might lead to socio-economic and political problems."

Looking ahead, the prospect of additional votes on EU membership are increasing uncertainties about the future of the world's biggest trading bloc. Analysts say this would hit the investment climate and consumer confidence on the continent, which is still reeling from a debt crisis and last year's Greek turmoil.

"For Europe, there is going to be a small impact from U.K. trade but the bigger issue is the uncertainty over the future of the single market," Bank of America Merrill Lynch's Mr. Wood said. "If the U.K. can do this, who's next?"

The effects beyond Europe are expected to be more muted, as trade with the U.K. represents a minuscule portion of the economic activity in the U.S. or China. But as investors piled into assets they saw as safe in the aftermath of the Brexit vote, the U.S. dollar rose, feeding concerns about U.S. companies' profits and investments.

"In the U.S., the concerns focus on whether the dollar could appreciate sharply and remain high, which, alongside the uncertainty that Brexit creates, could reinforce weakness in U.S. business capital expenditure," said analysts at Citigroup.

The bank said Brexit could shave off 0.1 percentage point from U.S. GDP growth this year and next and warned that the vulnerability of the internationally exposed U.S. banking sector to Brexit risk could further dampen U.S. growth.

For emerging markets, a stronger greenback makes their dollar-denominated debt and the commodities they sell more expensive. Still, these nations could benefit from prolonged ultraloose monetary policy in developed countries. Analysts expect the Brexit vote to derail the U.S. Federal Reserve's plans to raise interest rates this year, with the market assigning only a 5% chance for a rate cut by December, according to CME Group.

The cuts to growth forecasts have also led strategists to revise their equity-market targets downward. UBS Group AG has cut its target for FTSE 100 year-end to 5,500. On Thursday, it was trading at 6373.8. The bank sees the Stoxx Europe 600 ending the year at 340, from 326.6 on Thursday.

Write to Georgi Kantchev at georgi.kantchev@wsj.com

 

(END) Dow Jones Newswires

June 30, 2016 12:47 ET (16:47 GMT)

Copyright (c) 2016 Dow Jones & Company, Inc.
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