Saturday 1 October 2016

As June's D-Day looms, what would retreat from Europe mean for Britain?

Philip Shaw

Published 08/04/2016 | 02:30

David Cameron holds a Q&A session on the forthcoming European Union referendum with staff of PricewaterhouseCoopers in Birmingham. Photo: Getty Images
David Cameron holds a Q&A session on the forthcoming European Union referendum with staff of PricewaterhouseCoopers in Birmingham. Photo: Getty Images

The very flippancy of the 'Brexit' phrase belies the ramifications that a victorious 'leave' vote may have on the UK, European and in turn global economies. It's only 11 short weeks to go before the most hotly debated and crucial European referendum in over a generation is upon us.

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The various scenarios and impacts a 'leave' vote may have on the Irish economy have been well documented in recent months and with that in mind it may be worth keeping tabs on how we think the UK will manage the aftermath of such an event.

One obvious benefit for the UK (unlike Ireland) would be an even weaker pound, making UK exports instantly more competitive.

As a 'ballpark' figure we would suggest that sterling could fall a further 10pc from current levels, taking the benchmark EUR/GBP rate towards the £0.90 mark.

The pound, however, is likely to remain volatile after a 'leave' vote and direction will also depend on what sort of deal (eg on trade) the UK government sets out to achieve, how constructive/rancorous the talks are perceived to be and the general level of UK political uncertainty (eg, does Prime Minister David Cameron resign?) that is sure to follow.

FX hedging after a 'leave' vote would remain expensive as implied volatility/options prices would still be high, in our view.

There could also be wider effects on global markets. Negative trade negotiations would not be good for the euro area certainty (even outside the Republic). It is not impossible to envisage global risk assets being impacted on fears of global trade or currency wars.

From an administrative perspective, the immediate consequences of a successful 'leave' vote would mean that the UK would have to invoke 'Article 50' of the Lisbon Treaty. The UK and the European Council would have to assign negotiating teams to work out withdrawal arrangements and separate post-exit arrangements.

That negotiating period will be set at two years and can only be extended indefinitely by a unanimous EU member state vote.

From a trade perspective, the UK would no longer be part of the EU Single Market and as such any existing EU trade agreements would cease to exist after two years.

Agreement within two years looks highly optimistic; the first stage of the Swiss bilateral trade agreement took a whopping six years.

Agreements via the EU with 53 other third party areas would also cease. The UK would also have to drop out of the EU customs union and all UK exports would have to comply with EU Rules of Origin, which would be an obvious impediment to UK exporters.

Next up the UK would have to decide what type of trade deal it would ideally negotiate with the EU.

The three templates in place are:

1 The Swiss bilateral trade agreements: This involves tariff free access to the EU with limited access to the single market for financial services. The UK would have to adhere to EU principles including free movement of labour. The UK would be able to negotiate its own external trade policies. It would have no vote on EU legislation but might well end up accepting most.

2: The Norwegian full access to the EEA deal: The UK would have full access to the single market for goods and services (excluding fisheries and agriculture). It would accept free movement of people, labour market rules, banking and climate change regulation. The UK would not be part of the customs union and would have to make significant contributions to the EU budget. Similar to the Swiss deal, the UK would have no vote on EU legislation, but might well end up accepting most.

3: WTO 'Most Favoured Nation' agreement: Tariffs would apply and vary greatly across products with a current 4pc average EU import tariff. The UK would not be bound by EU financial regulation but may have to mirror regulation in order to "passport". The UK would not be obliged to permit free movement of people but concessions may be possible in any future agreements.

The current and persistent sterling weakness (two year lows vs the euro) is reflecting more what the polls and less what bookmakers are predicting. Much like the Scottish vote just over 18 months ago, the polls and odds leading up to the vote will be the main sterling drivers. Our central view is that the 'remain' vote will prevail to a global sigh of relief, sterling will rebound sharply and the squadrons of potential political and trade negotiators will be ordered to stand down.

Philip Shaw is Chief Economist at Investec London

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