European stocks to drop up to 15%; recession by year-end, says Exane

European equities could fall 10% to 15% in the next few days, said Exane BNP Paribas, while a UK recession by the end of this year looks likely.

“Financial markets will likely react in an aggressive manner this morning and the world has changed, but from a market perspective this is not a systemic Lehman moment. It is politics where the main uncertainty now lies, with central bank response also important,” the bank said.

Exane said that for anyone tempted to buy UK or European assets once such a floor is reached, the fundamentals remain tricky, with a number of unanswered questions such as how the UK will exit the EU, and how the spillover to Continental politics will play out.

“This non-binding referendum vote needs ratifying by the UK parliament to come into effect. There are possible scenarios where this never happens, but assuming it does the exit path looks lengthy and murky,” said Exane, adding that a recession looks likely.

“With the Brexit risk now realised, the UK will be hit by a combination of (1) a confidence shock, (2) a political/policy uncertainty shock, and (3) tightening financial conditions expressed through falling equities, widening credit spreads, and tighter bank lending conditions.

“Our base case is that this will be enough to tip the UK into recession by the end of this year, with the first negative reading of sequential quarterly growth in Q4.”

In terms of sectors, it said European financials and UK cyclicals were likely to take the initial hit, while risk aversion and US dollar strength would hurt commodity and emerging-market plays.

“On the (relative) long side, European QE beneficiaries and defensive USD-earners should outperform.”

As far as the pound is concerned, Exane reckons it will stabilise in the medium-term at a level 10% below pre-referendum levels. This would imply GBPUSD around 1.35 and EURGBP close to 0.85.