There has been a lot of news on the Brexit debate in recent days. UK Prime Minister David Cameron obtained a new draft for the EU deal at last week’s summit in Brussels, and set a date for the referendum (June 23rd, 2016). While Cameron supports the UK’s continued membership in the EU, 6 out of 22 of his government ministers declared support for Brexit, along with the very influential London Mayor, Boris Johnson. Mixed results from polls conducted after the latest announcements make it hard to confidently predict an outcome. Based on our internal analysis, we assess the probability of the UK leaving the European Union to sit slightly below what has been forecast by most recent polls. In terms of investment implications for European Fixed Income, we believe that a Brexit scenario would likely lead to lower ratings for the UK government and, by implication, potentially UK companies as well. The currency will likely continue to be under pressure.
What is the main news after last week’s summit?
At the EU summit, Cameron obtained almost all of his requests in the negotiations and announced that a referendum on the UK’s EU membership will take place on 23rd June. Following this news, a political fight among the ruling Conservative party erupted, with six government ministers (and rumors of one-third of all MPs) saying they favor an EU exit; this was exacerbated when the very influential London Mayor, Boris Johnson, also sided with the ‘Out’ campaign.
It is difficult to predict how this will end, but it is clear that in the past the UK benefited significantly from its distinct status of being part of the EU, but less integrated than in the case of monetary union. The benefit can be seen from the superior performance of the UK economy versus most Eurozone countries that, arguably, have not fully exploited the benefit of the single currency. Moreover, the UK could benefit further from a strengthened institutional framework going forward in the Eurozone. By contrast, it seems clear that the UK could lose a lot in the case of an exit, even though this is difficult to quantify. The position of the business community (and not only the financial industry) has certainly been in favor of the EU.
What does the deal include?
The deal accepts almost all of the UK’s requests, affirming that:
- The UK is exempted from the clause of creating “an ever closer union”; different paths of integration are allowed. A sort of mechanism for each Parliament to block legislation that infringes the subsidiarity principle has been formalized (within 12 weeks, signed by 55% of national Member Parliaments). [Workable]
- On governance (non-Eurozone vs Eurozone member states), and particularly on the Banking Union, the UK will continue to have its own supervisors and regulators; new legislation regarding the single rulebook will be required to take this into consideration. [A potential nightmare]
- On competitiveness, the EU council stated its firm intention to reduce the red tape burden on business and enhance the pursuit of free trade agreements. [Vacuous]
- For the next 7 years, access to in-work welfare benefits for EU immigrants can be restricted for a period of up 4 years. Income support for non-resident children will be parameterized to the income level of the country of residence. [Contentious]
What do you expect ahead?
Predicting the referendum outcome is still a difficult call, as different polls show conflicting results, and the extent to which Boris Johnson’s stance will influence public opinion is not yet clear. Polling results are quite a mixed bag, with telephone polls showing double-digit leads for the “stay” campaign, and online surveys depicting a much closer race, with the “leave” movement potentially ahead. The table below outlines the most recent results:
Importantly, the current picture suggests that undecided voters will play a crucial role. While voters with no specific stance are prone to support the status quo more often than not, the outcome will also depend on turnout among these undecided voters. That said, we assess the probability of the UK leaving the European Union to sit slightly below what has been forecast by most recent polls. This assessment is based on the following observations:
− The revised EU deal, Johnson’s move, and the setting of a concrete date for the referendum will prompt Prime Minster Cameron to intensify his campaign efforts to keep the UK in the EU;
− Chancellor of Exchequer George Osborne, previously a potential supporter for the leave-EU campaign, has aligned his stance with the Prime Minister, thus lending support to the pro-EU case. With the office of Prime Minister in sight, Osborne has now been challenged by Boris Johnson, also proclaimed by Tories as a likely successor to Cameron. Osborne has enough skin in the game to forcefully support a pro-EU vote.
What would be the possible investment implications of Brexit?
A Brexit scenario would likely lead to lower ratings for the UK government and, by implication, potentially UK companies as well. It could take up to two years for the UK to negotiate leaving the EU, and much longer to re-negotiate bilateral trade deals with all the UK’s trading partners. Investment decisions would be put on hold, the pound sterling would probably depreciate and inward investment would be at risk. That’s before trying to figure out what would happen to Scotland and Scottish companies (we would expect Scotland to seek another referendum on leaving the UK and on remaining within the EU). Overall, we believe a Brexit scenario would be negative for UK businesses and the UK economy. On credit markets, we foresee a modest widening of credit spreads, mainly driven by UK issuers but also by peripheral (Italian and Spanish) issuers, as the prospective implications of an EU break-up begin to be debated. In this vein, UK bank spreads have already widened compared to other banks.