If Britain quits the EU, investors will scramble to figure out what it really means. Beyond the inevitable blow to the British economy and shock to global financial markets, the political impact may be most lasting and damaging.
As campaigning heats up for Britain’s referendum on membership of the European Union (EU) on June 23, opinion polls continue to send conflicting messages. Our view remains unchanged: the most likely outcome is a vote to stay in the EU, but there’s still a material risk of Brexit—Britain deciding to leave.
The Economic Impact
There’s seems little doubt that Brexit would have a negative impact on the British economy, at least in the near term. But how significant might this be?
Initially, we thought Brexit was likely to have only mildly negative economic repercussions. But we’re now more concerned about the possibility that it could push the economy into outright recession.
There are three main reasons:
First, it’s become increasingly apparent that uncertainty associated with the risk of Brexit has already started to weigh on the economy.
Second, the doom and gloom scenarios being painted by the British government, the Bank of England and International Monetary Fund (among others) could turn into a self-fulfilling prophecy should the UK actually vote to leave the EU.
Third, the UK’s reliance on foreign investors to finance its twin government and household-sector deficits make it vulnerable to any shock, like Brexit, which might cut off the flow of foreign capital.
In spite of this, we’re skeptical about the certainty with which many forecasters—including the British government—predict an economic meltdown should the country vote to leave the EU. Put simply, there’s no clear parallel upon which to base a Brexit simulation. So while the direction of travel following a Brexit vote might seem clear, the magnitude most definitely is not.
Brexit: The Broader Consequences
While the domestic debate has, understandably, been dominated by the potential impact on the domestic economy, Brexit would also have broader consequences. Indeed, many observers claim it could pose major risks to the global economic outlook.
On the surface, it’s difficult to understand why. The UK accounts for just 2% of world output and it’s not clear to us why a decision to alter its future trading relationship with the EU and eschew deeper political integration with the rest of Europe should have a big impact on the global economy. All the more so as Brexit would entail a transition period lasting two years, perhaps even longer.
Of course, financial markets would respond adversely to the shock of a Brexit vote and a period of considerable turbulence would probably follow—with the pound certain to be the biggest casualty. But this is a “known unknown,” for which central banks have had time to prepare, making a systemic or lasting crisis unlikely. Eventually, we would expect markets to turn their attention back to other concerns: i.e., China, commodity prices and the magnitude and timing of Federal Reserve (Fed) tightening.
Where Brexit is likely to create lasting shockwaves is in terms of its political impact—both within Europe and perhaps further afield. Over the years, the UK has been an uncomfortable bedfellow for many of its European partners. Even so, a decision to quit the EU would be by far the biggest setback the European “project” had ever faced.
It would embolden radical and separatist parties that have already gained considerable ground elsewhere in Europe. And it might encourage investors to question the irrevocable nature of the single currency, at a time when the European Central Bank is already facing stiff criticism in Germany. The result could be another wave of the sovereign-debt crisis.
In the past, EU leaders have tended to respond to major setbacks by pushing ahead with deeper integration. A similar response is possible in the event of a vote to leave the EU. But we would question whether there’s still any appetite to go down this route—particularly given the leadership void and lack of strong government evident outside Germany. Europe has faced many challenges in recent years; a Brexit vote could create new difficulties as the region’s leaders attempt to hold the euro area together.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.