Brexit pounds

21 June 2016

The poll looms as a potentially disruptive event for global growth and trade, financial markets and the political status quo. Recent opinion polling suggests a close vote, with a small majority of voters now in favour of the UK staying in. Previous polls had leaned towards “leave”.

A “remain” vote probably would mean business as usual for the UK economy, the world’s fifth largest, and for Europe. But, what would a vote in favour of so-called Brexit mean? First, it is important to note that even if UK voters decide to “leave”, there will be no changes to arrangements for at least another two years. “Brexit” would require invocation of article 50 of the Lisbon Treaty, but the UK has up to two years to do this, and the deadline can be extended. There would also be lengthy negotiations involved, so it could take years for an exit to be formalised.

Uncertainty during this negotiation period, though, would likely be high. Financial markets dislike uncertainty and market volatility would increase, particularly in the near term. The British pound, which has already fallen sharply, would be particularly vulnerable, as would equity markets. Perceived safe havens like bonds and USD will be favoured. Government officials and central banks, and not just those in the UK and Europe, would be drawn into public reassurances that the disruptive changes can be managed successfully, but may have to offer policy support.

There are potentially serious political implications of the vote, too. A vote for “Brexit” almost certainly would end the term of British PM David Cameron, who has advocated strongly against Britain leaving. His position would become untenable if the vote was to “leave”, or even if the margin of victory for “remain” was small. A “leave” vote would increase strains in Europe and could open the floodgates for other European countries to hold similar votes on their EU membership. The end-game could be disintegration of the EU itself.

There already have been material economic impacts of the looming vote. UK businesses are said to have delayed investment until after the vote, and uncertainty has damaged confidence and dragged on household spending. The magnitude of the long term economic impact of a “leave” vote is contested by economists, with some arguing there would be a net benefit to the UK economy. This would come mainly via lower UK financial contributions to European economies, a lighter regulatory burden and the UK’s ability to negotiate new trade agreements.

The majority of economists, however, argue there would be a net cost for the UK of up to 4% of GDP over 4 years. A “Brexit” vote would mean the UK’s access to one of the world’s largest economic blocks would become problematic (the UK sends half its exports to the EU), a possible loss of foreign investment, and dislocation of migration flows. These would all be open to negotiation, though, with one fall back option being that the UK “leaves” while keeping the free flow of labour, particularly skilled migration, as is the case for other non-EU members.

Why should company directors far away in Australia care? First, there would be the financial market volatility in the wake of a “leave” vote, with currencies, including freely-traded AUD, exposed. Managers may want to examine their firms’ exposure to GBP. Second, the end of the UK’s membership of the EU means access for Australian firms with operations in the UK and Europe could be affected. Finally, a “leave” vote may have lasting implications for global cooperation and integration, including in free trade deals. Unfortunately, some of these impacts may become apparent only over the long term.