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About two years ago, Boris Johnson, wrote a biography of Winston Churchill. Over the past couple of weeks, this has led to a number of articles looking for similarities between the wartime leader and one of the headline acts in the EU referendum show. As opposed to shedding much light on Boris’ political manoeuvrings, these comparisons served mainly to remind me of a relevant Churchill phrase.
David Cameron’s return from Brussels, negotiation complete and agreement in hand is almost perfectly described as “…not the end…not even the beginning of the end. But…perhaps, the end of the beginning.”
In the run-up to June 23rd, we will be very short on certainty about the outcome, but incredibly well supplied with speculation and opinion, from every corner of the country. The “will-they, won’t-they?” aspect of the question is unanswerable at this stage, so we’ll try to look through the noise.
It is important to emphasise the difference between polling and probability. A poll showing 40% in favour of a British exit implies a near-zero probability of that outcome – although recent history shows that polls are a less-than perfect indicator. Trying to position investment portfolios for a low probability event is incredibly difficult, and often at odds with long-term goals. However, considering the impact of a major event, no matter how unlikely, is rarely wasted time.
A British exit from the EU will have countless ramifications, but the most important ones for investors come under three categories; economic, market and practical.
Assuming that an exit is smoothly achieved (which arguably is a big assumption), the economic impact of a British exit would over the long term likely be neutral. In ten or twenty years’ time the UK would continue to be a developed world nation, would still trade heavily with Europe, and would still have a service sector driven economy. London would still be an international finance centre, although perhaps slightly more tilted towards relationships with emerging Asian economies such as India and China. Individuals may end up better or worse off, but the health of the UK economy is not under threat.
The market impact will naturally be more immediate. In general, investors are becoming more aware that equity markets are not always a good proxy for an economy. This is particularly true with respect to the FTSE 100, given the international make-up of the index. As such, British worries tend to be less important than global concerns – the likes of BP, Glaxo and Diageo are not likely to worry too much about EU membership (despite CEO protestations otherwise).
In fixed income, the question of Britain’s solvency is not in doubt, and so we would expect to see the Gilt market continue to behave as a quality sovereign bond market, dictated by interest rate policy and safe haven flows.
The real vulnerability is Sterling, which has already been suffering as speculation surrounding the referendum increased – falling over 10% since December 2015 on a trade weighted basis. The susceptibility was demonstrated again by Boris Johnson choosing a side, and subsequently the Pound weakening by over 2% vs the Dollar. In the event of a British exit, Sterling could well devalue sharply in the immediate aftermath. For a newly independent Britain, looking to build global trade links, arguably this wouldn’t be such a bad thing. In the short term though, holidaying outside Britain would be a much pricier affair.
The practical impact for investors should be limited – cross border trading of stocks and bonds will still take place, as indeed it does now with nations outside the EU. The sale of funds into the EU under Ucits rules could come under scrutiny, but it would be counterproductive for both the UK and Europe were this kind of investment to be stopped – over €5 trillion is invested in these kind of funds, and unwinding a significant part of that would cause financial market panic. Neither Brussels nor the City will permit that.
Of course, all of the above is in a perfect world, and tends towards a medium term view. Although there is likely to be little disruption to daily UK life, headlines are likely to be screaming for some time. The two year period to arrange the exit will be rife with rumour and outrage, despite the fact that negotiations over trade deals are long-winded and dull.
Although the impacts above are generally benign, there are some worries. Brexit may breed domestic instability, particularly in the political sphere For example, what happens to UKIP? A party based almost entirely on the issue of the UK’s place in Europe will suddenly have no real direction. Will it disband? Or will it take a different route – and begin protesting about other issues? The issue of Scottish independence will also rear its head again. It is these kinds of issues that worry me in the long term, not the productive capacity of the British economy.