CAPA report predicts impact on growth of aviation in Europe with Britain out of the EU

The recently released CAPA aviation report forecasts a period of lull for the aviation industry in the entire European continent, followed by the shock exit of Britain from the European Union. The report mentioned that with Britain’s exit, negative impact on air traffic volume was highly likely, given a direct co-relation between GDP growth and passenger volume.

CAPA_ImageThe UK vote in favour of British exit from the EU came as an enormous shock to observers, despite strong warnings from pollsters, reads the CAPA report. “The first implication is for an unwelcome period of uncertainty. But, as with any major shock of this sort, the immediate warnings of disaster and market collapse normally dissipate as thinking adjusts,” it reads.

Noting that while the potential implications for the aviation sector were many, the most serious being the withdrawal of the UK from EU decision was going to allow the protectionist forces in Germany and France to become more influential in formulating EU policy directions. Uncertainty remains the order of the day, while the lengthy unraveling occurs, it reads. As per the report, for consumers, the single aviation market and the US-EU Multilateral open skies agreement remain the most immediate issues. For European services, the likely outcome is for the UK to negotiate single market access, as Norway and others have, through the ECAA, despite not being EU members.

It is highly unlikely that the UK will be excluded from the single aviation market

The UK referendum vote to exit the European Union is technically not legally binding on the UK government, nor on the EU, but politically the UK would have to perform contortions to override the popular decision. Despite some knee-jerk reactions on the EU side, Britain’s continued participation in Europe has enormous mutual benefits, too great for other EU countries to forgo.

Airports have become a much stronger force for liberalization; with Brexit, their importance grows

It has always been the case that airlines, notably flag carriers, have occupied extremely influential positions in determining aviation policy, nationally and supra-nationally, in the EU.

Brexit to hit air traffic demand through lower GDP, weakening of GBP and lower trade volumes

From an economic point of view, Brexit is likely to have a negative impact on air traffic volumes in three ways. Firstly, there is a well-established relationship between GDP growth and growth in passenger traffic, so any reduction in economic growth in the UK (and/or the rest of the EU) will be detrimental to demand for air travel. Secondly, the fall in GBP versus other currencies – in particular EUR – that has taken place since the referendum is effectively a price change for UK airlines’ air fares and this will affect demand due to price elasticity. Thirdly, air cargo volumes are closely related to levels of international trade, which are themselves affected by economic growth and trading agreements between nations.

Lower GDP could lower UK pax by 2.5% to 5.5% in 2020

Perhaps the most comprehensive summary of the economic impact on air traffic of the UK’s decision to leave the EU came from IATA in a 24-Jun-2016 report. The IATA report reviewed a number of scenarios on impact of Brexit on the level of UK GDP that have been produced by different forecasters: the UK Treasury, the OECD, the National Institute of Economic and Social Research and the Confederation of British Industry/PWC. Depending on the forecaster and on the nature of the (yet to be agreed) future trading relationship between the UK and the EU, UK GDP is expected to be lower in 2020 by 2.5% to 5.5% compared with the ‘no Brexit’ baseline.

Economic impact not only to be felt in the UK

In addition to the impact of Brexit on the UK, the economic fallout may also dampen economic growth in the rest of the EU. The UK is the biggest aviation market in Europe and any softening of air traffic demand there will be felt across the continent. Some, such as Barclays, have warned of the UK entering a period of stagflation (inflation and slowing/no economic growth.

Weaker GBP could lower pax by 1.7% and 2.9% over next two years

The more immediate economic impact on air travel to/from the UK comes from the drop in the value of GBP. Although many analysts predict that it will recover to some extent over the medium to long term, GBP is expected to stay 10% to 15% weaker than it would have been if the UK had remained in the EU.

The weaker GBP makes it more expensive for UK residents to make outbound trips to other countries, but it has the opposite effect on overseas visitors to the UK. Due to price elasticity of demand, this will reduce outbound air travel from the UK and increase inbound travel.

European airline share prices have been hit badly 

The reaction of European airline share prices to the referendum result has been predictably negative. This partly reflects a cold evaluation of the impact on demand, but is also the result of a more hot-headed fear of uncertainty. Investors have been understandably spooked by the negative impact Brexit is likely to have on air traffic, as highlighted by the IATA analysis outline above. Moreover, airlines are generally seen as cyclical “bellwether” stocks, to be avoided in any situation of economic uncertainty.

In addition, and more specifically, there have been profit warnings from both IAG and easyJet in connection with short-term demand softness, both in the run-up to the referendum and in the outlook this summer. However, more than that, airline shares are suffering because of the broader regulatory uncertainty surrounding the sector, particularly surrounding market access. Even if the UK maintains existing market access through membership of the European Common Aviation Area (ECAA) and becoming a non-EU party to the EU-US open skies agreement, demand for air travel will likely be hit by lower GDP and exchange rate movements as discussed. If market access is not fully retained, the impact could be greater and is harder to define. 

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