Why a decision to leave the EU will be costly for the UK economy and sterling assets

 

The outcome of the UK’s momentous referendum on whether or not to remain in the European Union (EU) is shrouded in uncertainty.

We do not pretend to have any more foresight into the result than the opinion pollsters and bookmakers who suggest the vote is hanging in the balance. However, we have more confidence in our view that there would be a negative impact on the UK economy and financial asset prices if the country opts to leave the EU.

In the following piece we bring together the views of our team of economists and investment professionals to help inform our clients’ thinking.

Firstly, we believe there would be a significant and negative knock-on effect on business sentiment, which would likely push the UK economy into recession towards the end of this year. And the consequences of a vote to leave wouldn’t just be felt temporarily. We would expect to see a permanent reduction in exports to the EU, while foreign-direct investment into the UK would also suffer, leading to higher unemployment and a decline in the country’s long-term growth potential.

Financial markets would undoubtedly react badly to a vote in favour of ‘Brexit’ too. We would expect an immediate and sharp fall in the pound. The UK runs comparatively large fiscal and current account deficits, and as such relies on foreign capital to finance the deficiency in domestic saving. If, as we anticipate, the uncertainty created by a vote to leave causes international investors to re-appraise their appetite for sterling assets, the decline in the pound could become more severe over time.

While the Bank of England would no doubt ease policy in response to any economic downturn, it seems unlikely this would prevent UK share prices from falling sharply. In particular, shares in smaller companies, which tend to rely more on the domestic economy, would probably underperform.

The impact on gilts is less clear. They may benefit from some domestic safe-haven flows, but at the same time, many international investors will be looking to sell.

Much can happen between now and June 23rd. And, as we have seen with any number of recent episodes, from the global financial crisis to the Greek debt tragedy, markets and businesses do not like periods of uncertainty. The UK referendum may finally bring some sense of closure to a debate that has dominated the political agenda since the General Election. However, a ‘Brexit’ vote could mean that the uncertainty for the UK’s economy and financial markets is only just beginning.  

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 22nd March 2016. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Some of the information within this document is based upon Aviva Investors estimates. It is not to be relied on by anyone else for the purpose of making investment decisions. This document should not be taken as a recommendation or offer by anyone in any jurisdiction in which such an offer is not authorised or to any person to whom it is unlawful to make such an offer or solicitation.

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This document is intended for distribution only to persons of a type specified in the DFSA’s rules “professional clients” and must not, therefore, be delivered to, or relied on by, any other type of person. This document is for the exclusive use of the persons to whom it is addressed and in connection with the subject matter contained therein. This communication is distributed in the DIFC by Aviva Investors Global Services Limited Regulated by the Dubai Financial Services Authority as a representative office with its address at Office 108, Al Fattan Currency House, DIFC, Dubai, UAE, and entered on the DFSA register under firm reference number F001481. The Dubai Financial Services Authority has no responsibility for reviewing or verifying this presentation The Dubai Financial Services Authority has not approved this presentation nor taken steps to verify the information set out in it, and has no responsibility for it. Contact us at Aviva Investors Global Services Limited, St. Helen’s, 1 Undershaft, London EC3P 3DQ. Telephone calls may be recorded for training and monitoring purposes.

Aviva Investors Global Services Limited, registered in England No. 1151805. Registered Office: St. Helen’s, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority and a member of the Investment Management Association. Contact us at Aviva Investors Global Services Limited, St. Helen’s, 1 Undershaft, London EC3P 3DQ.

 

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