By Guy Faulconbridge
LONDON (Reuters) - Britain's politicians must urgently get their act together after the Brexit vote and, if they fail to come up with a credible "Plan B" with a free trade agreement, sterling could fall towards parity with the dollar, Allianz economist MohamedEl-Erian has said.
El-Erian, chief economic adviser to Europe's largest insurer, which has around 1.3 trillion euros ($1.4 trillion) under management, said Britain faced greater structural uncertainty, lower economic growth and a higher risk of recession after the vote.
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But El-Erian, who was CEO of the Allianz-owned investment manager Pimco from 2007 to 2014, said much depended on whether politicians were able to provide a credible and swift "Plan B" that included a free trade agreement with the EU.
"After the Brexit referendum, the UK has to urgently get its political act together," El-Erian told Reuters in a telephone interview from Newport Beach, California.
"'Plan B' depends on the politicians in London and across the Channel, but so far they have not stepped up to their economic governance responsibilities."
The Brexit vote thrust Britain into its worst political crisis in modern times, with both major parties in turmoil and investors left guessing about how the future relationship with the EU will look.
David Cameron, who called the referendum, is stepping down as prime minister and his Conservative Party is selecting a successor whose main job will be to negotiate an exit from the EU.
Sterling dipped to a 31-year-low below $1.28 on Wednesday, having stood at $1.50 on June 23, the day of the referendum.
"Think of sterling as facing a double whammy with no strong anchor," El-Erian said.
He said there was concern on both the current account and capital account due to uncertainty about future trading relations and inflows of investment, while the Bank of England could not provide the anchor of higher interest rates.
"The future value of sterling is a function of how and how quickly the structural uncertainty is resolved – if Plan B is delayed and/or itdoesn't involve much of a free trade set-upwith the EU, it is not inconceivable for sterling to head to parity with the U.S. dollar.
"If, however, there is agreement between the UK and its European partners on a new arrangement that allows for sufficient free trade access, sterling could end up appreciating from its current levels."
Asked if Britain was really going to leave the EU, El-Erian said: "No one knows for sure."
"What Britain is realizing is that you cannot replace something with nothing, so there is understandably a go-slow approach on the part of the political class."
He said some sort of free trade arrangement with Europe was in the interests of both sides. "But it is not going to be a smooth road – it is going to be bumpy and there are going to be a lot of uncertainties and heated negotiations."
El-Erian said London, which major U.S. and British banks use as a platform to sell into Europe, would remain the second global financial center after New York despite Brexit.
Despite stiffer competition from Frankfurt, Paris, Dublin and Amsterdam, "no one will reach critical mass to challenge London’s overall European dominance".
He said he would be inclined to hold off investing in British banks due to lower interest rates and expectations of slower economic growth, but that there were buying opportunities.
Three British commercial property funds worth about 10 billion pounds suspended trading this week while Bank of England Governor Mark Carney said the financial risks of Brexit “have begun to crystallize”.
"There will be lots of attractive opportunities elsewherein the UK," El-Erian said. "We are starting to see that slowly emerge with commercial real estate, albeit we are at the very initial phases still."
El-Erian said the collapse of long-term government bond yields was due to lower growth prospects and the likelihood that central banks would be more aggressive with stimulus.
"I expect the Bank of England to cut rates and I expect the ECB to do more QE, as will the Bank of Japan. Combine that with lower growth prospects and the higher probabilityof a recession and you get lower yields," he said.
He praised Carney's handling of the Brexit turmoil: "If it were not for his steady hand, the financial instability that Britain faces would have been a lot higher."
El-Erian said that European investors in search of positive rates and the possibility of a currency appreciation had shifted money towards U.S. bonds.
"While the U.S. is in a better place economically and policy-wise, its yield curve has been captured by Europe – so while the U.S. controls its economic destiny, it does not control its yield curve," he said.
($1 = 0.9011 euros)
(Editing by Kevin Liffey)