Credit: Shutterstock photoApril 15 marked the official launch of campaigns on whether the United Kingdom should stay or leave the European Union. Since then economists and politicians have argued the potential impacts a Brexit would have on the global economy. A number of recent opinion polls have reignited concerns that voters are leaning towards leaving the EU. With less than 20 days left until the referendum, voters must weigh what leaving or staying actually means for them and the economy. While staying won’t solve many of its short term problems, leaving has the potential to spark a new international crisis.
Trade
One of the primary reasons of forming the European Union in 1993 was to lift the trade barriers across continental Europe. This created new opportunities to transfer goods and services relatively inexpensively and thereby stimulated economic growth. For the United Kingdom to leave, that would have a clear impact on trade.
They would be forced to renegotiate its access to European markets currently covered by 36 trade agreements and thousands of tariff lines. Currently, trade accounts for 40% of Britain’s GDP with over half of its exports going to mainland Europe. Torn up trade agreements would not just impact the U.K., but also the Eurozone. Ireland relies heavily on trade with the United Kingdom and would be one of the countries hit hardest from the move. In the short term both sides will see growth stagnate until a new trade deal is reached.
Impact on Currency
Hedge funds have started commissioning private polls to gain an edge in the currency market before Britain’s official vote. Foreign exchange will be one of the first markets to reflect the outcome of the referendum. In the event of a Brexit, the sterling will slide against other major currencies. Analysts at Goldman Sachs predict the sterling could depreciate by 20% while other studies are more bearish. To put this in perspective, the pound is currently trading at 1.44 USD/GBP with a possibility of trading evenly by the end of the year. The United Kingdom’s reluctance to change interest rates would also play a role in pushing the currency lower.
Financial Markets
The instability and turmoil created from a Brexit would send the market tumbling in the short term. Major market indexes like the FTSE 250 would see a large drop off. The index comprises of many small companies and exporters that would see earnings suffer from sterling weakness. A soft pound would also depress the dollar value of British assets in industries such as consumer discretionary, homebuilding and commodities.
Of greater concern is the possibility of large and sudden capital outflows, which would make the country’s current account deficit of 5 percent of GDP difficult to finance. Investors would likely demand a considerably higher risk premium on capital inflows required to finance debt. This is done in the bond market through monetary policies such as quantitative easing. The spread of 10 year yields on British Gilts and German bunds have already increased, likely pricing in Brexit uncertainty.
Productivity
The global economy is growing at a sluggish pace and a vote to leave could postpone a recovery even further. At the very least it has the power to stagnate growth in the region. Given the clear economic risks (less trade, currency headwinds, volatile financial markets and slower foreign investment), it is plausible to see negative growth and higher unemployment. Treasury officials recently issued guidance on two possible outcomes a year following a Brexit vote.
The first, more moderate scenario, would see GDP fall by 3.6%, unemployment increase by 520,000, the sterling depreciate by 12% and inflation rise by 2.3%. The second, and more concerning scenario, has GDP falling by 6%, unemployment rising by 820,000, the pound plunging by 15% and inflation increasing by 2.7%.
Concluding Remarks
With the current sentiment now favoring a vote to leave, citizens and investors should prepare themselves for weaker economic prospects. Whether these are temporary or transitional problems, they could take years to resolve.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
