The UK will decide whether to remain part of the EU on Thursday 23 June 2016. A pledge to hold this referendum formed a cornerstone of the Conservative party manifesto that helped them win a majority in the general election last year
Recent polls show that around 20-30%1 of the electorate will vote to remain part of the EU, a similar proportion will vote to leave and the remainder is undecided. It is likely that the result will be a close call and we expect this to remain the case up until the very end of the campaign.
How would a vote to leave the EU affect the UK economy?
In the long-run, it is hard to predict the impact as it is unclear what type of relationship the UK would be able to agree with the EU if it is no longer a member state. If the UK maintains a high degree of access to the EU markets, the economic impact will be less dramatic and various positives could materialise. On the other hand, if barriers to trade arise this is likely to have a considerable negative impact, given the large amount of goods and services that the UK exports to the region.
In the short-term, we think it will be an overall negative for the UK economy. The immediate risk arises from the high level of uncertainty that would be created. This could have a significant impact on business confidence and investment, particularly if the exit negotiations become drawn-out. Compounding the uncertainty is the possibility that a vote to leave the EU triggers another Scottish independence referendum, potentially leading to the breakup of the UK.
Against such a backdrop, we would expect the Bank of England to push back rate hikes, possibly until after the exit negotiations have finished. In addition there would be an increased likelihood of interest rate cuts in the near-term.
How would a vote to leave the EU affect UK assets?
We would expect a vote to leave the EU to have a significant negative impact on UK assets.
Firstly, we believe the British pound would weaken substantially. It has already fallen markedly this year due to the uncertainty around the referendum and we would expect a further devaluation if the result is a vote to leave the EU. This would be driven by increased capital outflows and a reduction in foreign investment as some companies may decide to delay investing in the UK while the exit negotiations progressed.
We believe longer-dated UK gilts would underperform swaps, as well as the sovereign debt of other developed market countries (for example, US Treasuries or German Bunds). This is because the increased economic uncertainty would reduce demand for UK debt and there could be a perceived increase in the risk of a UK sovereign credit downgrade or default.
In general, we expect UK equities to be adversely affected by the increased uncertainty and negative economic impacts. For many companies the effect would be mitigated by the fact that the majority of their earnings are derived outside the UK but the overall result is still likely to be market falls.
Real estate is the other major asset class that could be affected but we anticipate that the impact would be limited to office and residential space, mainly in London. Beyond this the impact should be smaller, although if UK economic growth slows in general, the rest of the market could also come under pressure.
1 Source: BlackRock