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Wedge of Worry

May 2016

The pound sterling risks losing more ground against the US dollar if Britain quits the European Union, says Abhishek Goenka, Founder and CEO, IFA Global DMCC

In the last three months, the pound has been moving in a wide range of 1.47 and 1.38 (900 pips) based upon the uncertainty surrounding Britain exiting the European Union. The European Union referendum will take place on June 23rd and the market participants have started to analyze the implication of the referendum on the Britain economy as well as on the European Union as a whole. The UK prime minister has set the date on June 23rd since the prime minister had to give a 16-week notice of a referendum, as per law. The prime minister has been vocal in stating that Britain shouldn’t leave the European Union as the economy will be safe, stronger and better off in a reformed EU. Consequences of the Brexit would vary depending upon the departure which would be renegotiated after a vote and also upon the prevailing economic climate. At this point of time it will be difficult to quantify the overall macroeconomic impact on the UK economy as well as the European Union because of this major upcoming event.

Trade implications

The EU is UK’s one of the most important trade partner accounting for almost half of UK’s exports and imports. UK’s association with the EU is important as it leads to lower trade barriers- making goods and services cheaper for its consumer. UK leaving the EU will not only lead to higher tariff and non-tariff barriers of trade but would also lead to slower productivity growth. As per the latest update received from the European commission, the EU is negotiating with some major new free trade agreements with the United States, Japan and Philippines. Reduced trade will not only lead to slower growth productivity but would also affect the economic regulation in the U.K.
Businesses across the board will be affected which in turn will have an impact on the UK’s employment number. The recent claimant count figures released from the U.K. suggests that the employment scenario continues to remain sluggish. The weak employment numbers suggest that businesses are refraining themselves from bringing new people on board ahead of the referendum. UK companies relatively have an upper hand in terms of supply chain when compared to companies in European countries. In a way to minimize potential economic losses, the EU is expected to focus on its post exit strategy, which will include negotiation strategy on free trade for all goods and specific services, where it is running surplus.

Political brunt

In the recent past UK’s influence in the European Union has been damaged by the ambivalence of the UK government to the EU. In a report released by the Britain government showed that the Brexit will make Britons lose £4,300 per year per household and at the same time exposing the economy to shrinkage of 6% by 2030. UK leaving the EU could make decision-making slightly simpler, particularly in areas where unanimity is required like social security. The real political risk is that the exit could trigger chain reactions, even where this makes obvious sense, as in the area of defense, foreign policy, defending the external boundaries of EU and certain aspects of environmental policy.

Will it be that easy for Britain to leave EU?

In his recent comments the Bank of England governor has already hinted that the Brexit is a risk to UK growth. The governor said that the impact of uncertainty is already being felt in ways of drop in commercial property transactions coupled with the fall in the currency that has been to the tune of over 10% since the beginning of this year. Once the referendum gets over and UK votes to leave the EU, the UK would trigger article 50 of the EU treaty. The vote will set the clock ticking for a withdrawal agreement to be reached within two years, or the UK would revert to the default trade agreement with the EU governed by WTO rules.

If Britain exits from the EU some of the visible, evitable and immediate consequences would be rise in yields of government securities, pound would start coming under pressure against the dollar and a negative impact will be seen in the equity segment as well. Brexit will also make it difficult for the BoE to raise rates sooner. On the other hand there has been a lot of speculation that the foreign direct investment will start shrinking but that looks less likely as Britain staying in the EU is not the sole reason for investment. The pace of investment could slow down as UK’s new relationship will be negotiated. In terms of benefit the country could have a more tailored immigration policy. Every year the British government could save about £10 billion on its contribution to the European Union budget if the country left the bloc. We expect the poll structure is tilted towards ‘No Brexit’ and we feel the same, in case the Brexit doesn’t happen the pound could move higher towards 1.5000. If Britain exits the EU the pound would be heavily battered and may break 1.40 levels on the downside.

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