Brexit: Big risk, little reward

By BlackRock

UK will decide in June to leave the European Union (EU) or exit the bloc. The upcoming referendum represents a critical juncture for the UK and EU alike, and comes at a time when the global outlook is clouded by unusual uncertainty.

Should I stay or…

UK voters have often been reluctant Europeans. There are clear economic benefits to integration with the world’s largest common market. Yet these benefits come with perceived costs. The leave camp, for example, points to a thicket of burdensome EU regulations, large EU budget contributions and big inflows of migrants from EU member states.

In this publication, we focus on the potential impact on the economy and financial markets of a leave or stay vote.

Chart: Relative strength between UK and rest of EU

Our key points are:

  • A newly independent UK would likely have reduced leverage to fashion trade deals for the crucial services sector and potentially less clout to negotiate regulatory standards for unimpeded EU market access.
  • The EU, for its part, would lose a major budget contributor, a leading voice for free markets and easy access to a world-class financial centre.
  • We see volatility in UK and European assets rising ahead of the referendum. An actual Brexit would hit global risk assets, we believe, whereas a vote to stay would likely reassure markets.
  • Sterling is most vulnerable to Brexit fears as it is the most liquid UK market. A Brexit could pressure the UK’s budget and current account deficits, hurting the currency and potentially triggering credit downgrades.
  • A leave vote would likely increase gilt yields. Portfolio inflows could falter, pressuring domestic sources of funding for the budget deficit.
  • We could see a Brexit dealing a blow to domestically focused UK companies, and would expect large cap overseas earners to outperform as sterling falls.
  • A Brexit would cut into the financial industry’s outsized contributions to the UK economy, tax revenues and trade balance, we believe, and offset apparent fiscal gains from leaving the EU.

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Sources: Bloomberg unless otherwise specified.

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