Brexit or Bremain… the lesser of two evils

Philippe Ithurbide is global head of Research, Strategy and Analysis at Amundi.

It would not make much sense to decide on an asset allocation according to future electoral results. On the other hand, scenarios and risks do have to be assessed, especially when it comes to an important electoral deadline, as the British referendum may be.

The latest polls seem to argue in favour of a Bremain (even if the Brexit camp has gained ground), and it is fairly common to see the Brexit/Bremain debate reduced to two conclusions:

1. A risk for the financial markets with the Brexit, an appeasement with the Bremain;
2. An economic risk for the UK and a political risk for the European Union.

Unfortunetely, it is not that simple. Here is our take on the issue.

What is the risk for the UK?
A clearly-defined economic risk: 50% of UK exports go to the European Union and, in terms of GDP, trade volumes with the European Union account for 65% of GDP (compared to 20% in the 1960s).

If the UK does leave the EU, trade volume and costs would be affected, and some segments that are highly integrated in the European Union, such as financial services, chemicals, or automobiles, would be affected.

A depreciation of the pound would certainly give British trade a boost but, according to estimates, due to the end of the European passport and the disappearance of trade agreements with the EU, the impact on GDP would be significantly negative.

The London Stock Exchange is in no danger, but there is no reason not to think that the EU could (should) take advantage of this new situation to promote the opening of a financial marketplace in Continental Europe.

For example, with regard to economic growth, the OECD considers that the UK would lose 3%-8% of its GDP while British employers announce that the EU by itself contributes 4%-5% of GDP, or about £70bn.

These numbers should be refined according to the different scenarios relating to “treatment” of the UK:
• If the UK stays in the European Economic Area (which currently has 31 countries), like Norway, the cost would be €3,345 per household per year (a reduction of 3.8% of its GDP over 15 years);

• If the UK signs bilateral agreements with the EU, as Switzerland has done in past years, the cost would be €5,528 per household per year (a 6.3% loss in GDP over 15 years)… Remember, though, that the negotiation of trade agreements takes between seven and 10 years on average!

• If the UK were to decide not to renegotiate with the EU, then the cost would be much higher at €6,689 per household per year in this case, i.e. a 7.4% decline in GDP over 15 years.

In light of the foregoing, we understand better why business leaders, the Bank of England, and the British Treasury, to name just a few, are warning UK voters about the consequences of a Brexit.

A not-insignificant political risk: By leaving the EU, the UK would regain its independence – and some seats – in the major international organisations, but it should be reiterated that the Brexit camp is not uniform – far from it.

Some (extremists) are demanding total independence, even the closing of borders (protectionism, stopping immigration), while others, liberals, want to ease the regulatory constraints imposed by the EU and be able to renegotiate all relations (including trade relations).

How can these two camps be reconciled if the Brexit wins? In addition, the risk of seeing Scotland demand a new referendum for its independence is high, since the Scots have never hidden their close ties with Europe.

And let’s not forget that the bulk of British oil is located in Scottish territory.

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