Brexit: Political contagion across EU is greatest risk, says Moody's

The British electorate's vote to leave the European Union will likely result in a shock to confidence that will curb UK economic growth, but political contagion spreading across the bloc remains the greatest risk, according to Moody's.

The ratings agency has reduced its growth expectation for the UK to 1.5% in 2016 and 1.2% in 2017, from 1.8% and 2.1% previously. Moody's has also lowered its euro zone growth expectations to 1.5% for 2016 and 1.3% for 2017, from 1.7% and 1.6% previously, reflecting "country-specific developments combined with limited spillovers from Brexit".

The agency noted that uncertainty around the future of the UK outside of Europe's common market will likely "dampen business investment and consumer spending" in the UK, as companies hold back on hiring and long-term investments and consumers postpone large spending decisions.

Elena Duggar, associate managing director at Moody's, said: "The downside risks to global growth stem not from the possibility of a recession in the UK, but from the possibility that developments in the UK may give rise to increased political risk elsewhere in the EU."

Duggar added that in the long run, the potential strengthening of nationalistic and protectionist movements could have a detrimental effect on the EU, "even threatening its existence".

The fragmentation of the trade bloc could also encourage protectionist tendencies in other countries, potentially halting the past few decades of increasing globalisation. This in turn would damage the long-term growth prospects of individual European economies.

However, Moody's said the US is largely insulated from the Brexit shock due to its limited direct trade exposure to the UK, which accounts for only 4% of US exports. "As such, absent a significant weakening in European growth, or prolonged financial turmoil, the impact on the US economy should be minimal."

Nonetheless, given the rise in financial uncertainty and mixed US economic data, Moody's does not expect the Federal Reserve to raise rates over the next few months. "However, the resumption of a gradual rate increase cycle remains likely, should the economy continue to expand at its current pace," it concluded.