By Matthew Borin
Many observers were stunned on Friday when the United Kingdom voted to leave the European Union (EU) by a margin of 51.9% to 48.1%.
Though the Remain campaign won by comfortable margins in Scotland, London, and Northern Ireland, the Leave camp dominated elsewhere. Polling had indicated that concern about immigration was the leading motivation for likely Leave voters, while Remain supporters were more focused on the economic ramifications of a so-called Brexit.
The result caught many investors off guard.
Betting markets put the chance of Brexit at about one in four before yesterday's vote, and Remain had trended up in recent polls. The pound sterling rose in anticipation of a Remain victory. As the initial results came in, however, the pound reversed course and fell below $1.33, its lowest level since 1985, making Friday the currency's worst day on record.
Politics Meets Policy
The pound's slide is likely related to the Bank of England's (BoE) policy dilemma. In addition to inflation pressures resulting from the devalued currency, S&P economists warn that Brexit could reduce UK growth by 1%. The BoE has not announced whether it will target growth or inflation, but with interest rates at 0.5%, the central bank has little room to maneuver. Andrew Haldane, the bank's chief economist, discussed these issues last year in a speech entitled, "How Low Can You Go?" The BoE has warned that it may be unable to prevent a recession. Chancellor of the Exchequer George Osborne also warned that UK housing prices could fall by 10% to 18% as European demand falls.
Risk assets are down globally as investors flock to perceived safe havens such as gold, bonds, and the yen. UK banks were down amid concerns about London's ability to remain Europe's financial capital. Countries that rely on trade with the United Kingdom, like Ireland, or hold many British assets, like the Netherlands, may be particularly exposed. Investors pulling out of Europe's weaker economies could indicate concerns about the future of the EU and other potential exit movements.
After the immediate turmoil, the United Kingdom's official departure could be a long and uncertain process. Article 50 of the Lisbon Treaty governs a departure from the union, but provides few guidelines. The United Kingdom will remain a member of the EU until it negotiates the terms of its exit with the remaining EU member countries. Triggering Article 50 starts a two-year countdown to an exit. Some expect that the two sides will take much longer to reach a deal and could extend the negotiations beyond that window.
Roberto Azevêdo, the director-general of the World Trade Organization (WTO), has warned that there is "no way of escaping" a long series of negotiations during which the United Kingdom must iron out trade agreements with the EU and other nations. The current UK government wants to wait for new leadership before pulling the trigger on Article 50. Prime Minister David Cameron, who led the Remain campaign, announced he will step down by the next Conservative Party conference in October, and a general election could follow.
But EU representatives are calling for quicker action in order to avoid a drawn-out and destabilizing process. The European Commission suggested that "Any delay would unnecessarily prolong uncertainty."
A post-Brexit deal could keep the United Kingdom in the single market, though many Leave voters would object if UK borders stay open. Failure to reach an agreement would result in the WTO rules - and significant tariffs - going into effect. Although it may be in the EU's best interest to reach a favorable deal with one of its largest trading partners, with so much at stake, the divorce may be acrimonious.
Brexit will have considerable political as well as economic consequences. There are political parties in the Netherlands, France, and elsewhere that are agitating for their own votes to exit the union. On the other hand, Scotland may hold a second independence referendum in an effort to join the EU, according to First Minister Nicola Sturgeon.
The majority of voters in Northern Ireland also supported remaining, and there are already calls for a vote on a united Ireland.
However the weeks and months ahead play out, only one thing is clear: The Brexit vote has marked a vivid turning point in global political and economic affairs.
- "International Banking in a London Outside the European Union": When euro transactions become harder to clear in London, the City may lose business to other financial capitals like Paris and Frankfurt. (Economist)
- "Populist Anger Upends Politics on Both Sides of the Atlantic": The United Kingdom's business and political leadership failed to stop Brexit. Is the United States on the same course with Donald Trump? (The New York Times)
- "Trade after Brexit." Once Brexit is finalized, £223 billion of exports could be subject to tariffs. Will the United Kingdom be able to negotiate a favorable deal with the EU? (Wall Street Journal)
- Three scenarios on how Brexit might play out: "What Are the Economic Consequences of Brexit?" (Financial Times)
- A timeline for leaving the EU: "After the EU Referendum: What Happens Next?" (BBC)
- Geopolitics for Investors: authored by former George W. Bush adviser and Brexit campaign supporter Pippa Malmgren. (CFA Institute)
- "Peter Zeihan on Geopolitics: 'A World That Will Fragment'" (Enterprising Investor)
- "The Return of Geopolitics: 'Markets Hate Uncertainty'" (Enterprising Investor)
- "Navigating the Fog: Geopolitics and the Global Bond Market" (Enterprising Investor)
Disclaimer: Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.