Alex Chappell

18th March, 2016

IC Insights

Brexit: What it could mean for the economy and financial markets

Founded in 1993 under its current name, but with origins stemming back to the 50’s, the EU is a union of 28 member states with an estimated population of 508 million people. It’s a means to share people, policy and economic prosperity, and one in which each member has a choice to be “in” or “out”. Britain’s vote will take place on June 23rd, although the campaigning and build up has already started in earnest.  

Britain’s relationship with the EU is complex and emotive, bringing about a highly political debate. This is reflective of the fact that there is very little independent research on the economic impact of a “Brexit”.  Due to this exact issue, one of our key asset management partners, Woodford Investment Management, commissioned Capital Economics to explore the economic impacts of a Brexit. We summarise their findings on each sector of the economy below:

Immigration:

The ability of the UK to restrict immigration will largely depend on its ongoing relationship with the EU. The most likely outcome is that policy will change to restrict the number of low skilled workers coming to Britain, shifting towards attracting more highly skilled workers. This could benefit sectors such as medicine and accountancy, but cause problems for the low wage sectors such as agriculture. In any case, we should have more control over the type of workers coming to our country and can align them to our requirements.

Trade and Manufacturing:

It is estimated that 63% of Britain’s goods exports are linked to EU membership. Although it is probable that a favourable trade agreement will be passed in the event of a Brexit, under a worst-case scenario the restrictions on trade are likely to be an inconvenience rather than a barrier. In addition, outside of the EU, Britain should also have more power to agree trade deals with the likes of the emerging markets. So although there is greater downside potential from less EU trade, there is also upside potential, providing Britain uses its freedom to negotiate to good effect.

Financial Services:

This sector has more to lose in the immediate aftermath of a Brexit than most. The City would most certainly lose control over the single market rules, but its competitive advantage is founded on more than just access. In a similar sense to trade and manufacturing, in the long term there would also be potential to broker trade deals with the emerging markets, but there is no denying that short term the risks are large.  

Foreign Investment:

Concerns about a drying up of direct foreign investment if Britain votes to leave the European Union are somewhat overblown. It is likely that Britain will remain a haven for foreign investment after an exit, even if there will be a short term slowdown in flows while the UK negotiates its new relationship. The biggest risk here will be the terms of negotiation, which are of course, an unknown.

Public Sector:

The Government could save circa. £10bn per year on its contributions to the EU budget if it were to leave. Having said that, it would only take a tiny economic disruption to offset these savings, and the government may continue to contribute to the Union depending on its renegotiated terms. The savings here are unlikely to be as big as people expect and there is even the possibility that it will cost Britain more to exit.

The Property Market:

This market has the most to lose from an EU exit, although this is likely to be concentrated to London. Foreign investment may slow, but should not stop, and the role of financial services to hold up the property market is probably overstated. Still, this is a key risk.

Overall:

The impact of the Brexit on the UK economy is uncertain, but Capital Economics doubt that its long-term economic prospects hinge on it. They argue that the more extreme claims about either the dangers or benefits lack evidence, and that overall the net impacts could be modestly positive, which opposes the conclusions of other studies.

Conclusions:

Britain’s economic prospects remain good, in or out, of the European Union. There are no particular areas of the economy that are likely to prosper or be hurt by a change in the status quo, although the effects are still largely uncertain.  

This uncertainty will be a negative for financial markets in the short term. Current volatility should continue, as investors look for direction in things they do not fully understand. Over the longer term, fundamental economic performance should prevail, however, the risk that a UK exit could accelerate a potential dissolving of the EU should not be underestimated.

There are always opportunities when any emotive macroeconomic event drives investment markets. Prices become disconnected from fundamental value, and over the longer term you can benefit providing you use these opportunities to your advantage.

Disclaimer:

Some of the contents of this report are a summary of the views expressed by Capital Economics and these are not necessarily shared by DB Wood. We try to ensure that the information provided is correct, but we do not give any express or implied warranty as to its accuracy. We do not accept any liability for errors or omissions. The content of this blog is for guidance purposes only and does not constitute financial or professional advice.

References:

Woodford Investment Management. 2016. The economic impact of “Brexit”. [Online]. Available at https://woodfordfunds.com/economic-impact-brexit-report/. [Accessed 02.02.2016].