- The UK faces EU membership referendum in June
- The financial markets may suffer due to increased certainty
- The long-term future of the EU is at risk in the event of 'Brexit'
When the Tories swept to power in the UK after more than 30 million votes were cast in the recent election, they will have known that a number of difficult decisions lay in store for them during their first year in power.
This is certainly the case at present, however, politicians in the UK remain locked in debate concerning the future of their countries' participation in the European Union (NYSEARCA:EU). Much of the discussion has been focused on the economic impact of withdrawing from the EU, and more specifically whether such a move would diminish Britain's GDP or empower it through a free trade movement.
Unsurprisingly, there are conflicting views and statistics on this subject. While research has suggested that an EU exit would permanently reduce the UK's GDP by an estimated 2.25%, thanks primarily to a drastically reduced level of overseas investment. Conversely, the UK may be able to boost its annual GDP by up to 1.6% by entering into a free trade movement and emulating Switzerland, although this depends on the precise economic model chosen and the cooperation from remaining EU members.
What about the financial Markets? The True impact of Brexit
These conflicting arguments reinforce two things. Firstly, a British exit from the EU will trigger huge levels of financial and economic volatility, as the region's economic structure evolves both in the short and longer term. Secondly, we must also consider the uncertainty that will ensue as Britain debates and makes its decision, which will arguably be more harmful than the repercussions of leaving the Union.
Such volatility will also reach far beyond the shores of Great Britain, however, wreaking both short and long-term havoc within the financial markets. In the near-term, for example, a British exit would impact negatively on the value of pound sterling assets and foreign exchanges, forcing traders to adopt a risk-averse approach when considering UK-based investment opportunities.
To understand this further, we need only look at how the referendum on Scottish independence drove down the value of the pound amid increased speculation and a lack of understanding of how the UK's economic model would adapt. The same fate will occur in the coming months and during the course of the proposed referendum in June, with the value of sterling plummeting and the vulnerable Euro exposed to even greater decline against the US dollar.
While this is good news for the dollar and a resurgent Yen, however, it will leave both the pound and the Euro inextricably linked by decline and volatility. This will also impact on the value of both sterling and Euro assets, with the stock market likely to show a decreasing demand for shares in British and EU corporations.
Even if both currencies begin to recover and grow once a decision has been made and the dust has settled, there are longer-term implications that may arise as a result of Britain's' revolt against the EU. More specifically, a successful negotiation by David Cameron's government may well encourage similarly powerful EU nations such as Germany and France to improve their own terms of membership, potentially creating greater volatility and forcing some nations to leave the Union.
If this happened, the very future of the Euro would be placed in jeopardy, so this is certainly something for investors to look for over the course of the next 12 to 18 months.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.