The UK will decide in June whether to remain in the European Union. I am unlikely to get below the surface of the debate here, but I believe the key issues influencing voters are the economy and immigration. As this is an investment article, I will focus on the former.
We have already felt the impact in currency markets, with sterling falling significantly against the dollar. In fact, December and January were the worst two months for the pound since the height of the financial crisis in 2008. Although this was due in part to falling interest rate expectations, market commentators are also highlighting the forthcoming referendum as a cause. Fears of Brexit are certainly rising, and the polls remain close. At the very least, scaremongering headlines in the lead-up to the vote are likely to cause currency and market volatility. The bookmakers’ odds suggest the remain camp is more likely to win, and that is our base case when making investment decisions. But we do need to consider the alternative scenario.
If we leave the EU, we would have two years to negotiate a withdrawal agreement – a much shorter timeframe than previous EU trade deals. This would be a period of significant uncertainty, politically and economically, which would undoubtedly cause market volatility and might forestall growth. Analysts at HSBC suggest that this uncertainty could lead sterling even lower, predicting a 15 to 20 per cent fall in the pound against the dollar and one-for-one parity with the euro. A weak currency means more expensive imports, in turn likely to drive up inflation in the UK. This currency move would, however, be positive for exporters, whose products would become more competitive overseas.
According to the research organisation Capital Economics, 63 per cent of Britain’s exports are linked to EU membership, though it shows there would be advantages for both sides in continuing a close trading relationship, even in the event of an out vote. In stock market terms, the significance is less pronounced, with Europe representing only 20 per cent of UK corporate earnings. From a sector perspective, UK financials and property are probably the most exposed to the risk of an exit. Our financial industry would suffer from any new barriers to EU access, and Brexit could pose a challenge to the City’s status as the dominant provider of investment services in Europe. Property investors, particularly in London, are understandably worried, having benefited from huge inflows of overseas investment in recent years.
The long-term implications are unclear and there is a lack of evidence to support any definitive conclusion on the economic costs or benefits of either scenario. Some companies and sectors are more exposed than others, and their share prices in the run-up to the vote will reflect this uncertainty. As investors, it is difficult to base long-term investment decisions on the unknown binary outcome of a vote, so the best we can do is understand the risks that we face in our charity investment portfolios. In the short term, we are likely to feel the swings in the campaign through investor sentiment, which should make for an interesting spring in both markets and politics.
Kate Rogers is head of policy at Cazenove Charities