The implications of a Brexit

BlackRock’s Ewen Cameron Watt explains the potential implications of a British exit from the European Union.

On June 23, U.K. voters will have to answer this question: “Should the United Kingdom remain a member of the European Union (EU) or leave the EU?”

The result of the referendum may be a close call, and uncertainty about the outcome is already having an impact on the U.K. economy. On February 22, for instance, the sterling tumbled to a seven-year low against the dollar, according to Bloomberg data, after London Mayor Boris Johnson came out in support of the “leave” option.

Our view on a Brexit

Many BlackRock clients are concerned about the possibility of a Brexit and have been asking for our view on the implications. To that end, The BlackRock Investment Institute recently published “Brexit: Big Risk, Little Reward | The UK Referendum on Europe,” a report that collates our thoughts on the matter.

We believe it’s a good idea that the U.K. stay in the EU. The economic and financial costs of a Brexit are material for the U.K., in our final analysis, both in the near and long term. And it’s not just the U.K. economy that would feel the effects of Brexit: The EU would lose a world-class financial center, a major budget contributor, a defense pillar and a leading voice for free markets.

However, it’s important that, on behalf of our clients, we analyze and assess the impact of a “leave” vote. As such, here’s our take on the impact of a “leave” vote on both the U.K. and the EU.

The impact of a “leave” vote on the U.K.

We see a Brexit vote having limited but noticeable impact on the U.K. economy in the near term—and likely significant implications in the long run.

In the near-term, we believe uncertainty (and volatility—markets hate uncertainty) would depress investment and growth in the months after the vote, and put pressure on the U.K.’s sovereign debt ratings.

In the longer term, we find it hard to believe an independent U.K. would be better off economically, barring a big rise in productivity or a much lower exchange rate, neither of which are guaranteed.

A worst-case scenario would be a vicious cycle of currency weakness, an abrupt stop to capital inflows and a sharp deterioration in market confidence. This could necessitate a rise in interest rates to prevent an overshoot in the exchange rate. The economic impact on U.K. gross domestic product (GDP), investment and job creation would be severe.

The impact of a “leave” vote on the EU

We see five main impacts on the EU:

1. The EU would lose a global financial center and easy access to world markets.

2. Defense of the realm.The U.K. is an important contributor to European security, spending an above-average 2 percent of GDP on defense.

3. The U.K. is not the only country skeptical about an “ever-closer union.” Would the EU break up? Probably not, but a few EU members, emboldened by a Brexit, could leave.

4. Free market voice. The U.K. has resisted attempts by EU institutions to increase economic regulations; would the U.K.’s absence tilt the balance toward less-friendly policy makers?

5. The U.K. is the largest net contributor (£9 billion) to the EU budget after Germany and France.

So which way will U.K. voters lean? A recent NatCen Social Research poll of polls points to a slim majority for the “remain” camp. The experience of referenda worldwide suggests the status quo tends to gain in the final stages of campaigning.

 

Ewen Cameron Watt is London-based Senior Director, BlackRock Investment Institute. He is a regular contributor to The Blog.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

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