Tuesday 30 August 2016 12:00 am

Brexit negotiation "pettiness" would push UK and Europe into recession, says Mohamed El-Erian

The UK and Europe will fall into recession and become less significant globally if Brexit negotiations become the victim of "pettiness", according to Mohamed El-Erian, Allianz's chief economic adviser who chairs President Obama's Global Development Council.

El-Erian said that in a "rational world, the UK would end up with a free trade arrangement with the EU", maintining "close coordination" over defence and foreign policy. But he fears this may not come to pass.

"The outcome would be very different if negotiation, however, were to fall victim to pettiness, hurt egos and domestic political posturing," he told City A.M.

Read more: Mohamed El-Erian on Brexit, Trump and the "improbables"

"This would tip both the UK and the rest of Europe into recession, fuel financial instability, and reduce the overall global standing and influence of all parties. A protracted and messy negotiation would also increase the likelihood of further fragmentation of the EU."

But El-Erian added that he expects the EU will end up, after the process, "slightly smaller but also stronger and more homogenous in vision from a longer-term perspective". He added: "I am not among those who expect a full collapse of the EU."

El-Erian said that he is a "long-term bull" on the UK economy, but "short-term more cautious".

The former Pimco chief executive also spoke of the dangers presented by negative interest rates.

"Most simply put, modern market-based economies are not constructed to operate well if nominal rates remain negative for a prolonged period of time," he said. "So if the current situation continues for a long time, things will start to break in a cascading fashion.

"Every day, negative nominal rates eat away at the integrity of the financial system. They undermine the provision of longer-term financial security products to the population, increasing the tendency to self-insure and adding to the upward pressures on the saving rates and holding back current economic activity.

"Negative rates can also hurt the credibility and effectiveness of central banks while, simultaneously, increasing their vulnerability to political interference."

Read more: El-Erian: "I would have left Pimco differently if I'd known about media circus"

Meanwhile, El-Erian believes the UK's ultra-low interest rates are "here for a while", because:

First, it will take time for the UK to recast its institutional setup in a manner that unleashes 'economic liftoff'.

Second, growth in the rest of the Europe, the country’s main trading partner both now and in future, is likely to remain weak, and with a periodic risk of recession.

Third, other systemically-influential central banks, particularly the ECB and the Bank of Japan, are likely to keep their stimulus pedal to the metal, thereby placing downward pressures on yields around the advanced world.