Brexit - count on further market volatility

15 June 2016

Next week’s Brexit vote has generated an environment of heightened uncertainty amongst local communities, businesses and financial markets. The closeness of recent opinion polls has weighed heavily on global stock markets and foreign exchanges as the risk of the UK taking a step into the unknown - and outside the EU - becomes a distinct possibility.

One counter to the uncertainty raised by the opinion polls has been the relative stability of the odds at the bookies. Although the odds on Brexit have shortened in the lead up to next week’s vote, betting websites still report the majority of bets taken are in favour of the UK remaining in the EU.

Given their relatively better track record at calling the 2014 Scottish independence referendum and 2015 UK general election, one seemingly sensible question is should we trust these bets over the polls? Perhaps having some ‘skin in the game’ (as punters are risking actual money as opposed to just giving their opinion) gives rise to greater thought about the issue of Brexit, and how the country may actually vote.

Nonetheless, there is evidence of a slowing in economic activity as businesses curtail spending, particularly investment, until a clearer view of the future is known has also impacted on interest rate markets. Investment decisions are medium-to-longer term spending plans that require firms to have a solid belief and high degree of certainty about the outlook for business activity and the political environment. That is not the case at present as the debate over the merits of remaining in or out of the EU is in full swing.

As opinion polls oscillate, businesses naturally are hesitant to commit to new capital projects, be they domestic or FDI. This uncertainty has been evident in the latest GDP data which show that in Q1 2016, the rate of growth in gross fixed capital formation was just 1.1% y/y, its slowest pace in three years. Ultimately, what we can say is that markets (and businesses) do not like uncertainty. A rate cut by the Bank of England by the end of the year is now priced at a greater than 50-50 chance.

While the pros and cons of the UK remaining a member of the EU have been widely published, what can we expect in terms of the immediate reaction to the result of the vote on Thursday 23 June? Whatever your position on the issue, one thing we can be sure of is continued volatility on financial markets around the vote.

Financial markets are set for a wild ride on Thursday as exit polls are released, shifting possibly into the early hours of Friday as the final results are made known. The common adage of ‘buy the rumour, sell the fact’ could well hold true, meaning that any upside on foreign exchange and stock markets may be limited should the UK vote to remain in the UK (as financial markets have generally concluded this to be the optimal event). A repricing in Bank of England interest rate expectations would however be likely.

Nonetheless, a vote in favour in Brexit is widely expected to trigger heavy selling in an acknowledgement of the extreme uncertainty that the situation of the UK having to leave the EU would present - no one really knows for sure what this would exactly mean, as no country has been through the process of exiting the EU and all of the legislative and other processes that would be required. True, there has been plenty of speculation around the timing of trade deals and changes in migration, but until these processes have been worked out, nothing is certain.

The Debtze Economist

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