Brexit: all eyes on the politicians

David Zahn is head of European Fixed Income, Franklin Templeton Fixed Income Group.

As the United Kingdom approaches its Brexit referendum on June 23, the one thing we can say with some certainty is that the ramifications, whatever the result, will likely be felt for some time to come—and not only in the United Kingdom.

In particular, we think politics will likely become an elevated issue for UK financial markets over the next few years as the UK’s ruling Conservative Party, whose Members of Parliament (MPs) have been deeply split on the Brexit issue, seeks to restore cohesion.

The current conservative administration doesn’t enjoy a large majority in Parliament. If a significant number of its MPs were to splinter off, the administration could conceivably no longer have a majority, and in that circumstance there would be a big question mark over whether the government would be able to govern effectively or even continue in power.

There is a widespread belief that if the United Kingdom votes to leave the European Union (EU), Prime Minister David Cameron, who has been spearheading the remain campaign, would stand down. The question would then be how his successor could get the ruling party back together again.

If the vote is to remain, it will be up to Cameron to reunite his erstwhile colleagues. In either case, it’s unlikely to be an easy task, and we think the uncertainty is likely to unnerve markets.

In addition, there may be some concern that the question of Scottish independence could rear its head again, notably if Scotland votes to remain in the EU but the United Kingdom as a whole chooses to leave. So we think the voting breakdown by region (England, Scotland, Wales and Northern Ireland) should be an important factor in the final reckoning.

That confusion could have considerable implications for the United Kingdom’s inward investment, including foreign direct investment and equity investment as well as its currency. And we believe that if there’s enough political unrest, it could spill over into Europe.

Exit signs spreading to other EU states
With polls predicting a very close result, we’re expecting the volatility in the UK equity and bond markets, and its currency, sterling, have experienced in recent weeks to continue up until the day of the vote.

But we also suspect there could be further volatility in mainland European markets as well, as more European political leaders make public their opinions in the run-up to the vote.

There are some indications that if the United Kingdom were to vote to leave the EU, calls for referendums in other countries could intensify.

Several political leaders, particularly those away from the mainstream but with growing popular support, are becoming more vocal in their criticism of the problems they perceive with the EU.

In general, we’re seeing evidence of growing dissatisfaction among voters with incumbent governments across Europe. European economic growth in general has been rather anemic, and people are looking for someone to blame.

Voters are starting to question whether the governments that are currently in charge should continue to be in charge.

That’s why we think there have been a number of elections in Europe where the status quo has changed.

In addition to blaming their own governments, there are signs that some people are also starting to lay the blame on a body that sits far away that they have never met and have no idea what it does— in other words, the EU.

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