The UK Has Voted to Leave the EU

Andrew J. Belshaw
Head of Investment Management, London

Executive Summary

  • The Leave result is huge surprise to both the UK and the EU, and a negative shock to the market, which had built in a premium for a Remain result.
  • Further policy response will have to be forthcoming from the Bank of England (BoE) and the European Central Bank (ECB) to stabilize financial markets and allay confidence hit.
  • The ramifications for the rest of the EU are potentially large. Will this lead to a further increase in support for Eurosceptic and anti-austerity parties? Will there be a move to hold referenda in other member states? It is impossible to say with certainty but the probability has certainly increased.
  • We expect to see a bifurcation in the performance in core and periphery bond markets. Core markets, especially Germany, should attract a safe-haven bid, driving yields lower and taking the yield curve further in to negative territory.

The UK has voted to leave the EU, a historic decision that will reshape and continue to send shocks through the market. Andrew Belshaw, Head of Investment Management, London, discusses the political and economic implications, as well as what this means for European bond markets and currencies, and the US and global markets.

What Took Place

  • 73% of the registered electorate turned out to vote; the UK voted to leave the EU by a margin of 52% to 48%
  • While London and Scotland voted Remain, the rest of England and Wales voted Leave
  • Turnout in Leave areas was higher than in Remain areas, suggesting Leave were better able to mobilise their votes
  • The swing that usually prevails towards the status quo did not materialise
  • This is a huge surprise to the market, which had built in a premium for a Remain result over the course of this week and immediately after the closing of the polls
  • This is a negative shock for both the UK and the rest of the EU

Implications

  • Economic
    • The vote will be a negative shock for both UK and EU growth in the short term
    • Policy response will have to be forthcoming from the Bank of England (BoE) and the European Central Bank (ECB) to stabilize financial markets and allay the confidence hit
    • Inflation risks are skewed further to the downside and we expect the BoE to cut its rates

  • Political
    • Having vociferously campaigned for a Remain vote, Prime Minister David Cameron announced his resignation on 24 June 2016, planning to step down by October, in time for the Conservative party conference. This was not a surprise given that his position had been severely weakened both within Parliament and with his Party
    • The Conservative Party will converge around a leader who can command a majority in Parliament. Failing this, the UK will hold an early general election
    • In terms of the exit mechanism, Cameron has left the decision on invoking Article 50 to his successor and it remains to be seen who will lead the exit negotiations
    • Given Scotland was decisively in favour of Remain, does this reopen the Scottish independence question? The Scottish National Party (SNP) obviously thinks so. However, the SNP no longer has a majority in the Scottish Parliament and would have to rely on other parties to help put the necessary legislation through, aside from securing an agreement with the Westminster Parliament
    • The ramifications for the rest of the EU are potentially large. Will this lead to a further increase in support for Eurosceptic and anti-austerity parties? Will there be a move to hold referenda in other member states? It is impossible to say with certainty but the probability has certainly increased. The Spanish Election (26 June 2016) will give an indication as to whether Eurosceptics have been emboldened
    • We expect EU politicians to be measured in their responses and not to inflame the situation with pejorative rhetoric, with an emphasis on the will of the British people, shared economic interests and a willingness to work together now and in the future

  • UK Bond Markets & Currency
    • This is a clear negative for the GBP. Given the UK’s record current account deficit and reliance on overseas capital, the uncertainty over future trading relationships and investment flows should lead to a weaker sterling. Additional policy action from the BoE (see below) will likely further undermine the currency
    • The BoE will have to, in our opinion, adopt a more expansionist monetary policy, not only to stabilise financial markets but also to shore up confidence in the wider economy. In the short term, this should cause gilt yields to decline but in the medium term, it should steepen the UK yield curve as risk premiums are built in against further capital flight and inflation risk
    • Risk assets in the UK (e.g., corporate bonds, high-yield and equities) should weaken initially as risk premiums increase. We expect BoE policy action to stabilise these markets in the short term, and rally in the medium term

  • European Bond Markets & Currency
    • As we have seen in past EU crises, we expect to see a bifurcation in the performance in core and periphery bond markets. Core markets, especially Germany, should attract a safe-haven bid, driving yields lower and taking the yield curve further into negative territory. Periphery yields should rise as the rise in probability of further countries leaving the EU is factored into spreads
    • We expect corporate bonds, high-yield, and equities to weaken as exporters weighed down by uncertainty and a lower growth outlook takes a toll
    • However, we believe the ECB through its current measures (quantitative easing, targeted longer-term refinancing operations and negative rates) may ultimately backstop risk markets, with further policy accommodation inevitable

  • US and Other Global Markets
    • We have seen a strong bid for US Treasuries while investment-grade and high-yield credit markets opened with a softer tone
    • Emerging markets debt and currencies declined sharply early in the day but have since recovered somewhat

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