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The investment consequences.

On 20 February UK Prime Minister David Cameron announced that for the first time since 1975 the British people would be asked to vote on the country’s relationship with its European partners in an “in-out” referendum on its membership.

in out club

The issue and its impact on asset allocation for both UK and European financial assets is a topic likely to be hotly debated at UK investment houses in the run up to the referendum on 23 June.

In this blog and subsequent follow ups we will explore its impact not only on the UK but also more widely to include the impact on European economies, currencies, bond and stock markets.

Unfortunately, the British debate has lacked objective analysis of the arguments for and against membership, with both ‘outs’ and ‘ins’ using evidence selectively to make their case.  Even the question itself appears to have courted controversy with the original question,

“Do you want to be in or out of the EU?”

ditched in favour of the less contentious,

“Should the United Kingdom remain a member of the European Union or leave the European Union?”

The Centre for European Reform has warned on the consequences of Britain leaving the EU, outlining five core areas where it argues Britain would be worse off if it left:

  • TRADE. If Britain were to leave the EU, it would face a difficult dilemma: having to negotiate access to the EU’s single market in exchange for continued adherence to its rules – or losing access in return for regulatory sovereignty that would be largely illusory.

  • REGULATION. Regulation is intended to create a single market, so that exporters do not have to comply with 28 different standards. If Britain wanted to continue to export to the rest of the EU, its exports would have to match EU standards. And if the UK joined the European Economic Area, or persuaded the EU to give it an à la carte relationship with the single market, the government would have to continue to sign up to social and environmental rules.

  • CITY OF LONDON. If Britain leaves the EU, banks would shift some of their activities into the EU. The remaining member-states would insist that Britain sign up to many rules in exchange for more limited access to European markets than it currently enjoys. A British exit would damage the City, rather than setting it free.

  • If Britain left the EU, future British governments would be more likely than not to curb immigration from the rest of Europe. But as baby-boomers retire and jobs are created at the high- and low-skilled ends of Britain’s labour market, demand for immigrant labour is likely to grow, not shrink.

  • EU BUDGET. Outside the EU, the British government would find it difficult to cut farm subsidies and development funds. All OECD countries subsidise their agricultural sectors. And Wales and Northern Ireland are large net beneficiaries of the EU budget: if EU spending were not replaced by funds from Westminster upon exit, their economies would shrink.

And UK bookmakers are certainly confident Cameron will win his gamble to take his case to the people offering skinny 3 to 1 “on” odds that Brits will vote to stay in the Union.

However, people have a habit of confounding pollsters as the Greeks proved last year when they voted a resounding “oxi” to the EU’s austerity plan on 05 July 2015, while only two months before that the UK itself saw pollsters upset by the general election outcome on 7 May when to widespread surprise Cameron’s UK Conservative party was returned with an overall majority.

And fundamentally, the “out” campaign has some pointed counters to the arguments the pro EU campaign makes:

  • TRADE. Britain’s trade is growing much faster outside the EU than within it. The percentage of trade outside the EU has grown from 44% in 1999 to 54% in 2014.

  • REGULATION. It is true the UK will still have to adhere to much of EU regulation, but the crucial point for the “outers” is that it will be up to the UK as to how we deal with it and deciding on it. Ultimately it will be for British courts and parliament where the final arbiter will be and not the European courts, Commission or parliament.

  • CITY OF LONDON. It is true that EU banks may shift some of their activities into the EU. It is also true that UK services are growing faster in the EU than the rate of GDP growth. However the outers respond that the advantages of the City of London, its location and cultural ties both in America and Asia, will make it difficult for EU banks to switch. Additionally their less liberal and more highly regulated regimes will mean much of the business is retained.

  • The outers recognise the need for immigration and the skills that immigrants bring to the UK. Their criticism is that this has become poorly handled and that the UK has little or no say over who it admits and the processes by which admission takes place. They also point to the poor infrastructure, schools and transport pressures uncontrolled immigration brings.

  • EU BUDGET. The out campaign argues that Britain overpays into the EU by £10bn a year which is 0.5% of GDP. It recognises the notion that EU agricultural subsidies will be cut, but argues that cheaper food will be a net positive for consumers.

In addition, the “out” campaign has recruited some formidable political backers such as Justice Secretary Michael Gove, former Labour foreign secretary David Owen and high profile London Mayor Boris Johnson who argue that sovereignty, the rights of the individual over those of the state and free trade, would ultimately be better protected outside the EU and that, far from suffering, Britain would thrive and set itself on a path of faster economic growth.

So against this background where do we stand on the investment implications of the vote? We believe there are three likely outcomes and we consider each in turn and likely investment winners and losers:

1. What happens if Britons vote to remain in the Union with a resounding yes?

Voters accept the core arguments of the in campaigners and the “in” campaign triumphs decisively.

Sterling strengthens 5% on a trade weighted basis, easing pressure on the euro too and other EU states breathe a sigh of relief. Consumer confidence improves and investors bias portfolios towards domestic exposures like retailing, leisure, and services. In this scenario UK and European banks too would attract investment as interest rates normalise and net interest margins improve. Immigration stays at high levels and the need for property stays concomitantly high, with the shares of house builders and suppliers all likely to outperform.

Europe wide implications would be that Germany would keep Britain as a fellow reformer within the EU and the positive vote would allow EU institutions to continue to progress in an orderly fashion.  The British government, alongside Ireland and the Netherlands, the Nordics and some member-states in Central and Eastern Europe, is comparatively economically liberal, and is a sceptical participant in the EU’s regulatory process. These countries especially would welcome a big “in” vote.

2. What happens if Britons vote to remain but the vote is tight?

Assuming a narrow “in” vote such as the French “petit oui” to Maastricht in 1993 or the Quebecois vote in 1995, this is likely to cause considerable uncertainty with concern about an increasing fracturing in the EU with pressures re-emerging on both sterling and the euro.

The euro would likely come under some pressure and David Cameron’s position in the Conservative party may come under threat. It may well prove to be a pyrrhic victory too as campaigners could justifiably argue that even with all the levers of the state the British government was not able to get its message across with waverers being pushed into voting for an in vote.

Best investments in this scenario would most likely be in safer, more liquid bonds and blue chip equities while UK exporters would benefit from a weakened sterling.

3. What happens if Britons vote to leave the Union?

If the UK votes to leave the EU we expect currency bond and stock markets to become volatile and sterling will likely devalue at least 10% and possibly 15% first versus the US dollar and then against the euro.


The UK current account deficit is high, both in absolute terms (£125bn in 2015) and as a percentage of GDP (5.9%, similar to Turkey as a percentage of GDP, and compared to 0.5% in France, 2.1% in the US and a current account surplus in Germany of 7.5%).

And these movements in sterling can be sudden, as evidenced in the ERM crisis of 1992 or during the great financial crisis of 2008.

Exports will revive and UK manufacturing especially would do well in the stock market as the UK devaluation gets underway.  In this scenario, even though as acknowledged by the PM and Germany’s Finance Minister Wolfgang Schauble, the British will arrange its own trade deals, access to the single market could no longer be taken for granted and a semi-detached relationship a la Norway and Switzerland may be difficult to achieve.

The various trade options at this point open to the UK would be membership of the EEA (the Norway option); a customs union, similar to the one the EU has with Turkey; a basket of bilateral agreements such as that which exists between Switzerland and the EU or a so-called ‘vanilla’ free trade agreement such as the ones the EU has with countries ranging from South Korea to South Africa. None would be straightforward, all would undoubtedly take time and much haggling to negotiate and all would undoubtedly be at risk from an EU smarting from Britain’s rejection.

And whatever the referendum result the problems in the eurozone will not go away and may even be highlighted by the campaign…

It is said markets hate uncertainty. Perhaps more accurate would be to say investors hate uncertainty while markets thrive on it. Whatever the truth, the entry of colourful London Mayor Boris Johnson on the side of the out campaign an almost uniformly hostile UK press, and split governing and opposition parties makes the job of convincing a sceptical public that much harder.

Whatever the outcome on 23 June and even if Britain votes to remain in the EU, the UK sits uncomfortably in a Europe that itself sits uncomfortably in the modern day global economy.  In a book just published by Bank of England governor Mervyn King, Mark Carney’s predecessor, and not someone necessarily given to hyperbole, his view that the euro is deeply troubled and EU reform will have to be far more radical than has so far been the case, Britain in or out, is hard to refute.

Any potential Brexit, or maybe even a split vote, would confront the EU with a set of challenges genuinely unprecedented in its history to date. The withdrawal of a member state would be a defining moment for the EU, to lose as large a state as the UK even more so. This is especially so given Britain will remain a growing European power, given forecasts suggest it will be Europe’s largest economy and population on current trends by 2050.   UK-EU relations will remain an important relationship for understanding European politics. The EU’s development – whether it unites, disintegrates or muddles through – will be shaped by a myriad of factors, one of which will be its relations with the UK. The EU therefore would have a calculation to make about Britain’s utility and how damaging or beneficial a Brexit could be.

It is not only the EU that needs to take this into account. Other European countries such as Norway, Switzerland and Turkey need to consider what a Brexit could mean for their relations with the EU.  For the USA, a Brexit would not be seen in a narrow sense of being about the UK and UK-US relations. The USA’s concerns will revolve around how a Brexit might change the EU, European politics, transatlantic relations, NATO, European security and the EU/Europe’s place in the wider international system.

It will be important in the months ahead that all sides handle these issues with great care, whatever is ultimately the outcome.

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