Slated for June 23, the Brexit referendum is tough to call and
impossible to ignore. Polls give the 'remain' camp an insecure
single-digit lead and predictions derived from political betting
imply a 65-70 percent chance UK voters opt to stay.
Polls and market prices are a poor security in comparison with the
size of the issues at stake, implying that some households and
particularly businesses will delay decisions and consumption until
after the election, curbing output regardless of outcome. Financial
markets have already moved, sending the pound lower against other
major currencies, and will likely become more volatile in the run-up
to the vote.
To be sure, the impact ahead of the vote will only be a small
fraction of the hit to growth Britain would suffer if it voted to
leave the EU, but a small percentage of a very large number is still
substantial. That’s because a 'leave' vote will produce a mare’s
nest, as Britain must negotiate the terms of its exit with the EU, a
process which would last at least two years and include numerous
separate risks in numerous countries. That’s even before we consider
that a vote in favor of Brexit would likely bring down Prime
Minister David Cameron and quite possibly result in a vote by
Scotland to leave Britain.
During the time after a 'leave' vote, British relations with Europe
would run more or less as they do now but no-one would really
understand for how long and what comes after. So while companies
inside and outside Britain would want to continue to do cross-border
business, their ability to understand the costs and benefits of that
would be highly impaired.
That’s enough of a risk to tilt many towards putting off investment
until matters become clearer.
After a vote, this impact will be magnified, according to Kallum
Pickering, an economist at Berenberg Bank.
“It is very likely that UK economic conditions deteriorate in the
short run, despite no real change to the UK’s EU status, because
economic participants will begin to act in accordance with their
long-term expectations, which will be materially weaker,” he wrote
in a note to clients.
SELF-FULFILLING RECESSIONS
Even though a vote to leave would hit sterling’s value which may
drive inflation higher, the Bank of England may well react by
loosening policy - either actual interest rates or through more
quantitative easing - in a bid to short-circuit what could easily be
a self-fulfilling descent into recession.
Societe General estimates a 0.50 to 1 percentage point annual hit to
British output for a decade following a vote to leave the EU, with a
notable hit to exports due to increased tariffs and tougher and more
uncertain conditions for Britain’s huge financial services industry.
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None of this is, of course, inevitable, nor is it to say that
Britain will necessarily do worse outside the EU than it would if it
remained. The future of the EU itself is far from clear and secure
even putting aside British willingness to remain, and trade policy,
which would be one of the biggest uncertainties after an exit, is at
a particularly unstable period globally.
One need only look at the election in the U.S. to see that the rules
of trade and globalization as they’ve been developed and followed in
recent decades are by no means a permanent reality.
That’s all highly speculative, but what isn’t is that uncertainty
over what the UK is and does is as high as it has been in the career
of all but the longest-lived investor.
And where there is high uncertainty, the easy bet is growing
financial market volatility. On some measures, markets are now
pricing in the highest amount of volatility on the FTSE 100 index of
shares seen in the past 15 years, a period which included the Sept.
11, 2001 attacks and the greatest financial crisis since the
Depression. That kind of volatility is costly now and, if sustained,
would rise in impact.
And all of this is before we consider that a vote to leave would
have an impact far beyond Britain, raising difficult-to-answer
questions and difficult-to-pay costs for a Europe already struggling
politically and economically.
These are the kinds of issues that rightly make people and companies
pause.
Everything in Britain may well stay the same, but while the costs of
leaving look higher, there will be bills either way.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
(Editing by James Dalgleish)
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