With the UK having voted yesterday to leave the EU, this is going to be an uncomfortable few days for the financial markets as they get to grips with the consequences of this historically pivotal decision. Although this is a binary outcome, the possible consequences arising from this decision are far from binary and to some extent will be driven by the strength of opinion. In terms of the spectrum of possible messages this referendum sends, from “Strong Remain” to “Strong Leave”, this has to be regarded as “Weak Leave”.
It is important to note that the economic consequences of this decision are not clear. The vote in favour of leaving (52%-48%) was not large enough to kill the possibility that the UK would retain access to the single market through membership of the European Economic Area. Although the cost of this is acceptance of the free movement of labour across the EU, which appeared to be one of the key driving factors behind the vote to leave the EU, the relatively marginal nature of the vote (plus the fact that survey evidence points to not inconsiderable support for this) means that this option remains in play. In this instance, the economic consequences of departure from the EU would be very much minimized.
The potential political consequences arising from this decision are many. For the UK, it is interesting to note that in contrast to the UK as a whole, Scotland voted decisively to remain in the EU (by 62% to 38%). This difference is large enough to raise a second referendum on Scottish independence as a not insignificant risk, although this is not an immediate threat and something that needs to be viewed as possible on, perhaps, a 10-year horizon.
It is to the UK’s advantage to extend the period until Article 50 is triggered. The Prime Minister has resigned this morning and it appears likely that it will not be triggered until a new leadership is in place, at the earliest. This process may take some considerable time.
The initial negative market reaction to this decision will undoubtedly be magnified by the strengtheningsense, in very final run-up to the referendum, that the outcome would favour the UK remaining in the EU. It is a given that trading in the early hours will be very volatile. Sterling is around 8% lower versus the US dollar, and 6% versus the euro. In the short-term, risk assets will react very negatively to this decision but the day is not over yet and sterling’s weakness will offer some protection to sterling assets. In this sense, European markets (financials especially) appear more vulnerable.
There will, almost certainly, be a significant stick-shift in monetary policy across the world – and in the UK especially - towards accommodative policy stance. Safe haven assets will remain well supported.
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