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Politicians on both sides of the debate over the U.K.s
secession from the European Union are fond of pointing out that
nothing would change the day after the vote. And that is
Every law and regulation in place the day before the vote
would remain in place until the
terms of a Brexit were agreed upon, a process projected to
take at least two years. But we can be fairly confident in the
short run that U.K. equity prices would not stay the same, nor
would the value of the pound. U.K. equities could see a further
2 to 3 percent sell-off, and there could be perhaps an
additional 10 percent fall in the trade-weighted value of the
pound sterling. If the polls had begun to point to a clear
majority favoring the Leave camp, much of this
would have occurred already.
How would a yes-Brexit directly affect the economy? Research
by my colleagues at J.P. Morgan Chase & Co. suggests that a
negative result could take about 1 percentage point from the
growth rate in the 12 months following the vote a
significant hit, given the baseline growth forecast of some 2
percent in 2016. At the same time, the further decline in the
exchange rate would tend to push inflation up.
In his inflation report press conference on May
12, Bank of England governor Mark Carney suggested the
central bank would face a challenging trade-off in
this scenario, between stabilizing gross domestic product
growth on the one hand and bringing inflation back to target on
the other. The monetary policy implications would not be
automatic, he warned. In the mid-term, Brexit could in
fact see higher official interest rates and lower growth for a
given rate of inflation, if leaving the EU lowered the
countrys supply-side potential by reducing its openness
to trade and hurting investment. In the short term, however, we
at J.P. Morgan Asset Management believe the negative hit on the
economy would dominate the monetary policy response. The first
rate rise would likely be deferred even further into the
future, and the chance of a rate cut or other stimulus measures
in the U.K. would go up.
Growth and investment in the rest of the EU would also be
negatively affected. Given its heavy reliance on trade with the
U.K., Ireland stands to see a major impact. The U.K. is the
euro zones single largest trading partner, with exports
to the U.K. accounting for 2.5 percent of GDP on average. That
figure is more than twice as high for Belgium, the Netherlands
and Ireland. The same J.P. Morgan analysts see a hit to euro
zone GDP on the order of 0.2 to 0.3 percentage points over 18
months following a Brexit vote. Because of the greater strength
of the euro against the pound, euro zone inflation might well
be slightly lower in this scenario. The reverse would be true
in the U.K.
Along with this macroeconomic reaction, we can expect a
microeconomic response on the part of businesses inside and
outside the U.K., as finance directors and other managers take
stock of their supply relationships and consider how their
costs, trading relationships, customer base and in some
cases even their legal status might be affected by the
decision. On such a microeconomic level is where the transition
costs of moving to a post-EU regime would be felt most keenly.
It could take several years for the nature of that regime to be
clear. That means businesses will be living with uncertainty
that much longer.
With more than 40 percent of the U.K.s trade going to
other EU countries, a new relationship with the EU would be
crucial to the impact on individual sectors, and that is where
the political economy gets tricky. In practice, there is a
trade-off between sovereignty and market access even if
the supporters of Brexit suggest that the U.K. can have access
to the single market without all the rules and regulations that
go with it.
The closest analogy to what the U.K. would face with a
Brexit is the Norway option: membership in the European
Economic Area, making a contribution to the EU and abiding by
all single-market rules, including free movement of people.
This is unlikely to appeal to those who want to see the U.K.
break free of Brussels, however, since it involves all of the
regulation that the U.K. has today but none of the influence.
Nonetheless, for the financial sector, EEA-only membership
would guarantee the continuation of passporting rights for U.K.
financial services firms to do business in the EU.