Where does the UK’s immediate future lie? No one knows but if Britain votes to exit the European Union there are likely to be widespread implications for investors
Casting aside the reckless decision to hold a June 23 referendum on the UK’s future within the European Union (EU), which can only have negative consequences on the UK economy whatever the result, there remains five key issues that investors should consider:
- Trade agreements. It is unknown how existing trade agreements would be treated. Clearly there are negative implications for future trade with the EU. If Brexit was to occur, there would likely be a negative impact on UK growth rates, employment and trade balance. In any subsequent negotiations, the UK Treasury has assumed an outcome that is close to the worst-case; a lengthy process in which the EU seeks to punish the UK for its decision to leave.
In this scenario, the EU is likely to play hardball to signal that leaving the EU (and/or the euro) has serious economic repercussions. However, others have argued that this may not be the case. If market volatility surges, then the pressure builds on the EU and the UK to reach an acceptable new agreement quickly.
- Political instability. Almost regardless of the final result, there is likely to be considerable political fallout. With the PM David Cameron and Chancellor George Osborne supporting the UK’s current position within the EU and London Mayor Boris Johnson supporting a Brexit, whoever loses will be under pressure to resign. There are those commentators that believe the Eurosceptic faction of the Conservative party would challenge the leadership in any case.
- Foreign exchange. Up to and until the result is known there is likely to be material exchange rate volatility that will be difficult to predict, not only in sterling but also in the euro. Why would the euro be impacted?
Although at least initially, most price movement would likely be seen in sterling, over time investors may become more concerned about the viability of the European project itself. Furthermore, the UK currently provides a strong political counterbalance to Germany and France. Some economists believe that a UK exit would lead to a weaker EU.
- Inflation. If there was a material depreciation of sterling, then it could be assumed that import costs would increase and this would put upward pressure on inflation.
- Interest rates. Given all the above impacts and others, the Bank of England (BoE) would have to determine the most suitable level of interest rates. The BoE would have the unwelcome job of balancing the probable increasing unemployment, higher inflation, deteriorating trade balance and lower GDP growth rates. The most likely outcome is that the path of UK interest rates would be lower than is currently expected.
The latest polls point to a close win for the ‘remaining’ camp. The Financial Time’s latest poll of polls (26 April) records 47% in favour of remaining, 41% for leaving and 12% undecided; the Economist’s latest poll of polls (28 April) puts those figures at 42% to remain, 40% for leaving and 16% undecided. On 28 April, Bloomberg ascribed the probability of a Brexit at 21%, down from 24% two weeks earlier.
It should be noted that the poll results have been volatile and the various methodologies used have been criticised. Furthermore, recent political polls haven’t been particularly accurate, for example the Scottish independence referendum.
In summary, the result is still too close to call, but I think on the balance of probability the UK will remain in the EU. I also agree with most economic analysis’ that concludes the risks of a Brexit are not fully priced into the financial markets.
As I see them, the risks of a Brexit are asymmetric. If the UK remains, there would likely be a small rally in sterling and to a lesser extent the euro. However in the event of a Brexit, there would be considerable falls in both currencies.
GBP:AUD one year
EUR:AUD one year
If you would like to take a view on Brexit and express that by holding bonds in either sterling or euros, we have access to the following.
EUR Bonds
| Company | Maturity / call date | Trading margin | Bond type | Capital structure | Yield to maturity | Running yield | Capital price |
| BHP Billton Finance USD Ltd | 22/10/2024 | 3.83% | Fixed | Tier 2 | 4.32% | 5.16% | 109.050 |
| National Capital Instruments | 29/09/2016 | 0.00% | Floating | Tier 1 | 0.18% | 0.70% | 100.750 |
Note: prices accurate as at 3 May 2016, but are subject to change.
For wholesale investors only
GBP Bonds
| Company | Maturity / call date | Trading margin | Bond type | Capital structure | Yield to maturity | Running yield | Capital price |
| Glencore Finance Europe | 27/02/2019 | 3.29% | Fixed | Senior Debt | 3.19% | 5.98% | 108.750 |
| Rabobank Capital Funding Trust IV | 31/12/2019 | 2.88% | Fixed | Tier 1 | 3.90% | 5.27% | 105.500 |
| Elm Bv (Swiss Rein Co) | 25/05/2019 | 3.19% | Fixed | Tier 1 | 4.16% | 5.94% | 106.093 |
Note: prices accurate as at 3 May 2016, but are subject to change.
For wholesale investors only