‘Brexit’ Expected to Rattle U.S. Economy, Shake Its Influence

Officials worry U.K.’s vote to leave European Union will drive up dollar, depress exports and weaken diplomatic leverage in Europe

By Ian Talley

June 24, 2016 12:22 p.m. ET

WASHINGTON—The United Kindom’s exit from the European Union is expected to jolt the U.S. economy, rattling restive 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, the pound sterling at one point plunged to its lowest level in more than three decades against the dollar. Against Japan’s yen, the pound sunk than 15%, prompting Japanese finance officials to say the finance ministry is weighing a response to the surging currency.

To help reassure jittery markets, the Group of Seven largest industrialized economies issued a statement saying they were monitoring global currency volatility and prepared to act against disorderly markets. The G-7, which often scrambles emergency meetings and statements in the midst of global crises— also gave the green light for countries to intervene in their currency markets to tame damaging gyrations.

The U.S. Federal Reserve, along with the other advanced economies, said Friday they are ready to use their dollar swap lines to ensure financial markets don’t lock up. In the wake of the 2008/2009 global financial crises, the Fed and other major central banks opened up standing short-term credit lines to cover currency shortages overseas.

“We will work closely with both London and Brussels and our international partners to ensure continued economic stability, security, and prosperity in Europe and beyond,” U.S. Treasury Secretary Jacob Lew said after the Brexit results were announced. “The UK and other policy makers have the tools necessary to support financial stability.”

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.

“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.”

Analysts said the Fed would likely have to push back plans to raise interest rates, possibly into next year.

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 under secretary of State.

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, who’s now a senior counselor at the Albright Stonebridge Group. “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.”

President Obama said the U.S. would seek to preserve its diplomatic, strategic and economic relationships with its closest allies.

“The United Kingdom and the European Union will remain indispensable partners of the United States even as they begin negotiating their ongoing relationship to ensure continued stability, security, and prosperity,” Mr. Obama said Friday.

Analysts say a critical element of U.S. security policy in Europe, the North Atlantic Treaty Organization or NATO, isn’t likely to suffer from the Brexit. The U.K.’s membership in NATO “remains a vital cornerstone of U.S. foreign, security, and economic policy,” the president said.

One critical question is what will happen with all the U.K. trade agreements signed or being negotiated under the EU’s aegis. President 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.

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 Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics. “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.

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 Mr. Kirkegaard—and the vote likely will force a reshuffle of assets across the EU. Inflation will surge as the pound falls and living standards will subsequently fall.

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.

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.”

—Felicia Schwartz and Takashi Nakamichi contributed to this article.

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