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U.K. Shocks the World

Sunil Swami, Chief Investment Officer | JUN 24, 2016

United Kingdom Leaving European Union

In a historic referendum that shocked much of the world, the United Kingdom has voted to leave the European Union. Financial and political chaos has ensued, with Prime Minister David Cameron resigning and world markets  plunging.

Polls leading up to the referendum were close, but favored those who wanted Britain to “remain” in the EU. But with this unexpected result, risk assets including global stocks, high-yield bonds and commodities such as oil sold off sharply, as has the British pound. Investors seeking safety are buying government bonds such as U.S. Treasury, gold and currencies such as the U.S. dollar and the Japanese Yen. Markets were off their worst levels of the day as global finance officials said that they stand ready to ensure market stability. Bank of England Governor Mark Carney has made 250 Billion pounds of additional liquidity available and promised more if needed.

Where do things go from here?

Following the vote, the UK government is likely to invoke Article 50 of the Treaty on European Union, which provides for a two-year period for negotiating a country’s withdrawal from the EU. Article 50 has never been invoked, which raises significant uncertainty regarding the process for negotiating and securing EU approval for an exit agreement. Negotiations are expected to be tough as the EU will want to send a message to other countries who might be thinking of doing what Britain did. 

Tension over exports?

The EU is the UK’s largest trading partner, with about half of UK exports going to EU countries and exports to the EU accounting for about 13% of UK GDP in 2014 (Source: IMF). These exports benefited from access to EU markets without having to meet regulatory requirements at the individual country level and from EU trade agreements with over 50 other economies, which may now require re-negotiation. 

Is a financial crisis looming?

While very few leaders expect a financial crisis like 2008, a prolonged exit and negotiation process will likely create a significant drag on UK exports and overall economic growth and a smaller drag on EU growth. For the United States and Japan this would imply stronger currencies, weaker exports and weaker corporate earnings. Given the global impact of Britain’s exit from the EU, the chances of a global recession are now higher than they were before this event.

The longer-term fallout for global economies and financial markets will depend on what happens with anti-EU forces in other countries. Scotland wants to remain in the EU, which means that the Scots are very likely to have another referendum on whether to stay in the UK. Signs of political contagion are already present as anti-EU politicians in Italy, France and Netherlands are calling from referendums in their countries.

About the Author

Sunil Swami, Chief Investment Officer

Mr. Swami has decades of experience in the investment management and related fields.

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