Fra Commerzbank:
The EU referendum vote is still very open but EU supporters are already sounding shrill warnings about the impact of Brexit. In the event of such an outcome, we believe a tidy divorce is more likely than a messy one. After all, the EU also has an interest in avoiding an escalation.
A long-term sustained sterling depreciation beyond the inevitable weakness on the day after a Brexit decision is only likely if the EU signals that it will deny the UK access to the single market. The polls: Everything to play for Until recently, the Remain supporters were ahead in the polls. However, as the chart on the front page shows, Brexit supporters have now taken a slight lead after averaging across all surveys and corrected for institute-specific biases.
1 The bookmakers’ odds still suggest a somewhat stronger remain camp (58%), but the probability of staying in the EU was as high as 80% at the end of May. All in all, the outcome of the referendum is open. The box on the next page outlines when initial information on the outcome could become available. The legal framework for Brexit negotiations If the British decide to leave the EU on Thursday, Article 50 of the EU Treaty regulates the exit procedure.
Firstly, the UK would have to inform the European Council, i.e. Heads of State and Government, of its intentions. The Council then lays down guidelines as the basis for the EU to negotiate an exit agreement with the UK. The exit treaty would have to be decided by the European Council by a qualified majority; unanimity is not necessary. If the UK and the EU cannot agree on the terms of an exit within two years, the exit becomes legally valid without any regulations in place, for example, on continued participation in the EU single market.
That said, the EU could agree with the UK to extend negotiations beyond two years.2 UK wants to maintain access to the single market Exit negotiations would not only be about implementing an exit in the narrower sense but also about future relations between the UK and the EU. The UK should have a strong interest in maintaining access to the EU single market. Once the tabloid papers have stopped rejoicing about a Brexit, the British public will soon start demanding that withdrawal from the EU must not cost any British jobs.
Only a messy divorce on the surface However, in the past few days, EU representatives have made it very clear that it does not want to comply with the UK’s wishes in exit negotiations. Council president Donald Tusk has even rejected negotiating with the UK about single market access before withdrawal from the EU and noted: “That would take at least five years, and I’m afraid, without any guarantee of success”.
All in all, the UK would then have no safe prospect of close economic ties with the rest of Europe for at least seven years. The fact that a Brexit would be a rejection of the single market has also been made very clear by German finance minister Wolfgang Schäuble: “In is in, out is out“. On the surface, the hard line adopted by the EU is understandable. After all, it wants to stop other EU member states from following suit.
But there are weighty arguments against a messy divorce, implying the UK leaves the EU without any agreement on access to the single market: • Obstacle to trade: Although 47% of British exports go to the rest of the EU while only 7% of continental EU exports go to the UK, the UK is still the second largest trading partner of the EU after the US. The EU therefore also has an economic interest in keeping the UK in the single market. • Market turmoil: In the event of a messy divorce, heavy turbulence on the financial markets would be likely, which the EU could contain if it were to signal a willingness to reach an amicable agreement. 1 We have corrected results for institute-specific distortions.
The word “distortions” is not meant judgementally here and does not imply anything about the quality of the different forecasts. However, without a relative valuation of the various institutes, the average deviation of the surveys of one institute from the average of other institutes has to be considered as the “institute-specific distortion”. We smooth the poll results adjusted for this effect with a so-called kernel smoother.
2 “Legal framework for a Brexit”, The EU has a profound image problem. An increasing proportion of its electorate does not regard its actions as democratically legitimate. If the EU takes umbrage after a Brexit decision and denies the UK participation in the single market, it is not only the EU sceptics who would view this as lacking respect for the democratic decision of the British.
The EU cannot afford this. All in all, a tidy divorce, with some kind of access to the single market, is more likely than a messy divorce. In this case, after an inevitable slump on the day of the Brexit decision, sterling should recover again in the medium term. After all, the market will initially factor in the failure of negotiations with a non-zero probability, but respond with relief once the EU gradually adopts a more conciliatory tone. Tidy divorce based on Norwegian or Swiss model
There are essentially two ways in which the UK could maintain access to the single market after Brexit3 : • EEA solution: Iceland, Liechtenstein and Norway are part of the “European Economic Area” (EEA), and thus the single market, without being members of the EU. For this, they have to comply with many EU regulations without the right to a vote on them. Furthermore, they have to pay a contribution to the EU budget, which in the case of the UK could be around two thirds of its current net payment to Brussels. Even so, Brexit would mean that the UK had the advantage of being exempt from EU regulations not relating to the single market.
• Swiss solution: Switzerland is not part of the EEA but has concluded bilateral agreements with the EU in some areas. Consequently, it does not have full access to the single market in all segments (e.g. financial services) but also makes a smaller contribution to the EU budget. Box: When will we know the result? The polling stations close on Thursday, 23 June, at 10:00 pm local time to give all working people the opportunity to vote. Exit polls have in the past often provided very reliable results as to the outcome of elections and are allowed to be published after voting ends. However, they are less likely to be useful this time around due to the one-off nature of this vote.
Some market participants have commissioned exit polls and will have their results earlier than 10.00pm although they are not allowed to publish before that time. Consequently, GBP exchange rates could already signal the outcome of the referendum on Thursday evening. More reliable information will only be available once the first results from the 382 constituencies are available from about 1:00 am on Friday. At around 6:00 am, an estimated 90% of votes should have been counted. The final result of the referendum is expected to be known between 7 and 8 am local time. 3 ‘Brexit: A Primer’, Economic Insight, 3 September 2015 4 17 June 2016 Economic Research | Week in Focus But what will happen in a messy divorce? If the EU remains on a confrontation course in the case of Brexit and the UK ultimately loses full access to the EU single market at the end of the two-year negotiations, this would hit the country’s economy:
• Relapse to WTO rules: Without an agreement with the EU, WTO rules would apply. Tariffs would then be introduced for trade between the EU and the UK. With the exception of agricultural products, these would be in the low single-digit percentage range, but they could still disrupt production chains across borders. What’s more, British companies would have to prove that their products comply with EU standards. This is likely to make the UK less attractive as a production location.
• Banks: If a bank has a banking licence in an EU country, it may have branches in all other states of the EEA and offer services across borders (single passport for financial services). Without a single-market regulation, this privilege would no longer exist and many European banks would presumably reduce their presence in London. This would affect the British economy, which is strongly dependent on banking services.
Brexit supporters would argue here that leaving the EU would allow the UK to raise its free economy profile versus a dirigiste EU and thus become more attractive as a production and banking location. The vision of the UK as the “better Europe” does have its charm, but this would only be a vision that would have to be realised first against certain internal resistance (e.g. from the Labour Party), while the disadvantages would be much more concrete in the case of a messy divorce. If no association agreement with the EU can be reached after Brexit, prolonged and quite negative market reactions would therefore be likely.
Sterling could depreciate by about a third against the currencies of its trading partners. Indeed, a Brexit with a messy divorce is only partly factored in and the UK’s current account deficit is already high, at 5% of GDP. And if the UK remains in the EU If the British vote in favour of remaining in the EU on Thursday, sterling would recover after Brexit nervousness since the beginning of June has increased substantially. But this does not mean that the UK or the EU could simply move on to the next agenda item:
• Even if Prime Minister Cameron’s position is confirmed, he would still be under pressure from EU sceptics within the Conservative Party. They would not give him any peace and would destabilise the government. • Anti-EU parties are gaining strength not only in the UK but also in many EU countries. And because of these forces, governments are not daring to address the unresolved problems of the Monetary Union by e.g. submitting themselves to tougher budget rules or transferring more competence in financial and economic policies to Brussels. “More Europe” has become too unpopular.
Consequently, the causes of the sovereign debt crisis have still not been tackled, which is forcing the ECB to gloss over the problems with monetary easing. The many negative side-effects of this policy (pension problems, housing bubbles, etc.) are grist to the mill for EMU sceptics and will continue to strengthen their position in the long term. The residual risk of a breakup of the Monetary Union remains a real one even if the British vote in favour of staying in the EU.
