The shock of Brexit

With the referendum on Britain remaining in Europe taking place on 23 June, there are still 15-20% of the voting population undecided, with much to play for, for both the Leave and Remain campaigns. ING’s economist team explored the various arguments being promulgated by each side.

ING’s senior economist James Knightley looked at the factors that will drive voting intentions and the implications of a UK Brexit, while Chris Turner, global head of Strategy at ING examined the vulnerabilities of GBP and its potential path should Brexit materialise.

 

The three key political drivers for leaving

  • Immigration. One of the main arguments being used to support the Leave campaign is the lack of control Britain currently has over immigration and the impact this is having on the economy in terms of depressing pay and putting pressure on public resources. However, immigration from EU countries accounts for less than half of immigration as a whole, with most migrants still arriving from non-EU countries. Britain has remained an attractive destination for economic migrants because of its robust markets, but as unemployment decreases across Europe, migrant flow will stem and numbers are likely to drop over the next 3-5 years.

 

  • The cost to the British taxpayer. While the EU is often depicted as a financial burden, Britain currently spends around £8.5bn on EU costs in net terms - a fraction of national debt. To put this in perspective, Britain spends around 12 times more on state pensions.

 

  • Sovereignty. Membership of the EU is also often associated with burdensome red tape and laws and regulations that originate from Brussels. However, OECD data comparisons on regulation suggests that this isn’t the case and while many laws do have their origins in the EU, they would still need to be met by exporters to the EU if the UK were to leave.

 

The implications

  • Currency. To price sterling and to determine risk premium, ING uses the financial fair value model (rate spreads, shape of yield curve etc.) and then looks at how the currency is trading against it. Today, we estimate that there is a 4% risk premium for sterling, which is likely to increase ahead of the vote. A Brexit scenario could lead to an additional 10-15% sell-off in sterling, giving EUR/GBP a value of around 0.90. A remain result would likely see sterling bounce back partially to 0.76.

 

  • Trade. Leaving the EU could have a long term detrimental impact on trade, where the renegotiation of agreements could be protracted and difficult. However, the immediate threat would be to investment and jobs. For most countries, foreign investment accounts for 5-10% of total investment spending, while for the UK it is around 20%. This leaves the UK exposed to changes in foreign investor sentiment that could materialise due to Brexit fears. Another concern is the financial sector, with a significant portion of major banks potentially looking to move jobs to Europe should Britain vote to leave.

 

The final consideration is for the wider impact that a Brexit might have on other EU members. There is a growing momentum behind a number of anti-EU parties and a successful exit for Britain could lead to significant political risk for other states and an uncertain future of the European Union.