Instead of arguing for or against British withdrawal from the European Union, we look at the likely outcomes if Brexit were to happen.
Picture the scene: The votes have come in showing that the British have not believed the strapline that “Britain is stronger in Europe” and the great debate about Brexit is over. Today is the first day of the next two years that will determine just how “Great” an independent Britain really is.
What will the UK’s relationship with Europe look like?
This is the key question that will create a great deal of uncertainty and could result in a great deal of damage. This uncertainty stems from the conflicting demands the UK has from a relationship with the EU and the cost the EU would charge in exchange.
The UK would favor an agreement that:
• Maintains easy access to the EU markets for UK businesses
• Has some control over the movement of people (addressing the current immigration concerns)
• Allows deregulation
• Has an ability to vote in EU decisions
However, this is a hefty wish list that has yet to be granted in any EU relationship and is unlikely to be without considerable concessions by the UK. UK politicians would have to manage a trade-off between what was in the best interest of the economy and how much political power they were willing to cede. Negotiations would be long and arduous, with enormous pressure to reach a swift agreement that all parties accept — a task few would envy.
In the meantime, let us turn to the financial and economic implications of Brexit over the next two years and beyond.
Currency
We believe that the British pound, which has already dropped 5-6% in the run-up to the Brexit vote, has room to drop up to 12% further.
A weaker pound could be helpful for the UK’s current account deficit, although a very large drop in currency would be required to cover the deficit and, in the long term, the pound is not expected to remain that weak.
The equity markets could also benefit from a weaker pound. Of the companies comprising the FTSE 100, some 70% of their earnings come from outside the UK, and with a weaker pound we expect an increase in earnings, which is positive for equities.
Interest rates
The Bank of England (BoE) would undoubtedly push out the prospect of rate hikes and might even go as far as to cut rates, as long as the pound was not in free fall. This easing would likely be mirrored by the EU in the face of uncertain market conditions and losing one the world’s financial epicenters, the city of London.