(From Generali Investments). The Generali Investments Focal Point, issued on March 2016, analyses economic risks related to the potential Brexit from the European Union and its impact on economic risks, GDP growth and financial markets. An extract is provided below, while the research paper is available here
Highlights
On June 23, British voters will decide on whether the UK will leave the EU. The Referendum date was announced by PM David Cameron after he re-negotiated the terms of Britain’s EU membership at the European summit on February 18/19.
The most important results of the deal were:
- The UK extends its "special status" within the EU, including an exemption from being part of an 'ever closer union'.
- As a safeguard for the City of London, the deal affirms non-discrimination for non-eurozone members by decisions regarding the euro and the European financial rules.
- Countries can be authorized to limit non-contributory in work benefits to newly arriving EU workers up to four years. Special regulations were found for child benefits.( This topic is of special importance, as it is intended to limit immigration, a key concern driving many people’s voting decisions).
What next?
- Recent polls point at a tight race. While the reform agreement between the EU and the British PM David Cameron has helped to strengthen the ‘Remain’ camp, immigration concerns may favor a ‘Leave’ vote amid the EU refugee crisis.
- A ‘Leave’ vote would be followed by up to two years of negotiations over the terms of the ‘Brexit’. This will be a period of high uncertainty while EU regulations continue to be applied. Investment and overall growth in the UK may suffer on high political and legal uncertainties.
- In the longer term, growth would soften from receding immigration, trade barriers for financial services and less foreign direct investment.
- On financial markets, the strongest initial response would be seen in the exchange rate. The British pound may weaken noticeably on ebbing capital inflows while UK Gilts and equities in local currency may be less affected.
Economic risks tilted to the downside include
- Goods trade: The EU is UK’s largest trading partner (54.1% in 2014). In the worst case, the UK would fall back to WTO status with an average EU tariff of about 4% (but individual sectoral tariffs may be much higher). However, we see an EFTA solution (continued free trade in merchandise products) as more likely.
- Service trade: It seems likely that financial services based on the euro would, in part, relocate from London to Frankfurt or Paris. On top, the UK would lose its influence to shape EU financial legislation. Finally, a similar argument applies to foreign direct investment (FDI). The UK has likely benefitted from FDI of non-EU multinational firms as a platform to access all EU.
Read more on Generali Investments Focal Point
Authors: Thomas Hempell, Michele Morganti, Christoph Siepmann