Brit Exit Drives US Dollar Up

WASHINGTON (Dow Jones) -- Britain's exit is expected to jolt the U.S. economy, likely rattling restive equity markets and driving up the value of the dollar. It could also weaken U.S. diplomatic leverage in Europe and upend the corporate strategies of U.S. companies based in London.

Top finance officials say the damage from the so-called Brexit alone isn't likely to be enough to nudge the U.S. into a contraction. But as skittish investors pull out of U.K. and European markets and pour into the safety of U.S. assets, a falling pound and euro could cause the dollar to surge, further suppressing demand for American exports.

As results became clear that the anti-EU campaign was the winner, sterling plunged more than 10% to its lowest level in more than three decades against the dollar. Against Japan's yen, the pound fell more than 15%, prompting Japanese finance officials to say the finance ministry is weighing a response to the surging currency.

Analysts said the Group of Seven largest industrialized economies would likely be forced to issue a statement saying they were monitoring global currency volatility and were prepared to act against destabilizing volatility. Signaling the broader likely fallout from a British exit, the euro also sank against the dollar and the yen.

U.S. officials worry a Brexit will weaken the U.S. economy if growth in America's largest trading partner, the EU, takes a hit from a U.K. decision to leave. U.S. markets swooned and swelled in recent weeks in tandem with polls that showed a Brexit more or less likely to succeed.

"The U.K. vote to exit the European Union could have significant economic repercussions," Janet Yellen, chairwoman of the U.S. Federal Reserve, told Congress this week. A Brexit would "usher in a period of uncertainty" and fuel volatility in world markets. "That would negatively affect financial conditions and the U.S. economy."

U.S. Treasury Secretary Jacob Lew said ahead of the vote, "I only see negative economic outcomes" were voters to decide to leave the EU.

At the same time, Washington frets Brexit will cause strategic and diplomatic rifts between the U.S. and many of its closest global allies.

"If they are no longer part of the European Union that means they don't have a seat at the table when the European Union makes difficult decisions," said Wendy Sherman, the lead negotiator in the Iranian nuclear talks and a former top State Department official.

Brexit could also distract the continent at a critical time, undermining U.S. strategic interests. The referendum could cause "a period of inward-looking by the European Union," said Ms. Sherman. "That means they are less able to deal with Ukraine, less able to deal with the pressures from Russia, and less able to deal with transnational issues like migration, refugees and counterterrorism."

Christine Lagarde, managing director of the International Monetary Fund, said the exact size of the impact on the U.S. economy is unclear, given all the uncertainties about how the vote will weigh on the U.K. and Europe's economy and financial system. But "significant volatility and uncertainty prolonged over time" would likely fuel turmoil in U.S. financial markets.

A vote to leave is expected to sour investor and consumer confidence, incite market uncertainty and spoil spending appetites in Europe, maiming the region's already anemic growth. European officials have scheduled emergency meetings to help calm financial markets and prevent contagion into weaker economies. Many economists say the U.K. could be pushed into a recession.

Brexit will almost certainly hit the City of London, one of the world's largest financial hubs. Ahead of the vote, U.S. banks said it could force an overhaul of their business in the U.K.

"It won't be the center of euro-denominated transactions anymore," said Jacob Kirkegaard , a senior fellow at the Peterson Institute for International Economics, and will likely force a reshuffle of assets across the EU. Inflation will surge as the pound falls, and living standards will subsequently fall.

But the damage won't likely be isolated to the U.K., the world's fifth-largest economy. "A Brexit victory will also signal victory for populism in Europe," said Mr. Kirkegaard. "This referendum has unleashed fairly destabilizing elements into the European project."

And that will deliver a potentially significant jolt to confidence in the European economy, he said.

Collectively, the EU is almost the same size as the U.S. economy, one still struggling with high unemployment, weak investment and feeble growth.

Another EU slowdown would sap demand for U.S. exports as consumer confidence withers and the dollar strengthens.

In deciding to hold off on another rate increase at its last meeting, the Fed cited the risks from Brexit and strong dollar.

The dollar's strengthening could be significant. The IMF already estimates the dollar is 10% to 20% over the value that economic fundamentals warrant.

One critical question is what will happen with all the U.K. trade agreements signed or being negotiated under the EU's aegis. President Barack Obama said in April the U.K. would go to "the back of the queue" if it voted to leave the EU, and companies, investors and officials are unsure what the new tariff landscape would look like in a departure.

Those uncertainties, and a host of others, aren't likely to dissipate soon and could weigh on the U.K., European, U.S. and global economies for a while.

Matthew Peterson, chief investment strategist for Boston-based brokerage firm LPL Financial, said the long, uncertain process of disentangling the U.K. from the EU "means that any impact on the economy will be months or years in the future."

(KA)