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The Impact of a Brexit from the EU
Abdur Chowdhury, Ph.D. Chief Economist
February 2016
Volatility has jumped across currency markets this year because of wider concerns about China,
European banks, negative interest rates and volatile markets. The last thing investors need is
more economic uncertainty with the breakup of the world’s biggest free-trade area. With United
Kingdom’s (U.K.) referendum on whether to leave the European Union (EU) set for June 23rd,
investors are beginning to worry that it could be another major concern for them with unknown
outcomes.
The long-run impact of a vote to leave is impossible to assess. Major unknowns after an exit
include market access to the EU for the City of London, the potential for stand-alone trade deals,
and the danger that Scotland would once again insist on another independence vote.
In the short run, the investors and traders are, however, focused on a sharply weaker pound. The
British pound fell to a seven-year low against the dollar after the announcement of the
referendum. Investors are using options to hedge against a fall by the pound.
Exchange Rate: US Dollar per British Pound
1.65
1.60
1.55
1.50
1.45
1.40
1.35
Feb-16
Jan-16
Dec-15
Nov-15
Oct-15
Sep-15
Aug-15
Jul-15
Jun-15
May-15
Apr-15
Mar-15
Feb-15
Jan-15
1.30
Source: Board of Governors of the Federal Reserve System
Leaving the EU would likely hit pound on several fronts. Impacts would likely include significantly
lower economic growth for the U.K., capital flight, reduced direct investment in the U.K. and the
Bank of England would likely need to keep its easy-money policies in place for longer.
There are other asset classes that could be affected following a referendum. Topping the list
would be London’s property market. London’s housing prices have been among the most
expensive in the world, in part due to overseas demand and immigration, and so will be
susceptible to price drops if the U.K. leaves the EU. Gold may also benefit as the potential for a
U.K. exit adds to political and monetary risks that can push investor money into gold. In equity
markets, U.K. companies with significant European exposure could be hit if access to Britain’s
biggest trading partner is affected.
The impact wouldn’t just effect the U.K. A vote to leave could be catastrophic for confidence in
an already fragile Europe. The pound might suffer the most, but the euro would also come under
pressure against other major currencies. Even worse for the common currency, the European
Central Bank would surely become even more dovish if faced with two years of uncertainty while
U.K’s exit details were negotiated.
So what could this mean for the U.S. economy?
One immediate effect would likely be a strengthening of the U.S. dollar. The dollar has already
strengthened nearly 25 percent in the past eighteen months as investors began to anticipate the
prospects of higher U.S. interest rates. The high exchange rate has already been blamed for
crimping exports and putting deflationary pressure on the U.S., and could be a new key source
of risk for the economy in 2016.
Feb-16
Nov-15
Aug-15
May-15
Feb-15
Nov-14
Aug-14
May-14
Feb-14
Nov-13
Aug-13
Feb-13
May-13
Trade Weighted U.S. Dollar Index: Broad
130
125
120
115
110
105
100
95
90
Source: Board of Governors of the Federal Reserve System
An even stronger dollar would also tend to keep downward pressure on commodity prices. This
of course would continue to benefit consumers and businesses that are helped by lower import
prices. But it would continue the woes of America’s oil production industry, including its hiring
and capital expenditures.
Frankly, the UK has very little to gain by quitting the EU and much to lose. Opinion polls indicate
the British population is divided over EU membership with the chance of a British exit currently
as high as 40%. Irrespective of the twists and turns of the ‘Brexit’ debate, the uncertainty over
the vote could continue to weigh on both the U.S. and global financial markets in the coming
months.
Dr. Abdur Chowdhury is a Professor of Economics at Marquette University, the Chief Economist at Capital Market Consultants, Inc. (CMC) and a member of the
Federal Reserve Board of Chicago’s Academic Advisory Council. CMC provides capital market, investment manager and economic research to financial professionals
(for more information about Capital Market Consultants, Inc. see our website at (www.cmarkc.com).
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