The Road to Referendum : It's going to be a long one ..... so very, very long

Tuesday 23rd February 2016

The Road to Referendum : It's going to be a long one ..... so very, very long

ref :- "Traders struggle to price in Brexit" , the Financial Times , Currencies Analysis

Where to start ? Actually, given that it will be a whole four months until the British people have their say and then presumably some time before the ramifications of the referendum result are assessed, we wish we didn't have to start on this topic quite so soon. Those living in the UK in particular are likely to get heartily sick and tired of the entire Brexit issue well before the vote itself. But with Sterling immediately under the cosh, falling to a 7-year low versus the USD after PM Cameron's announcement of a June 23rd referendum to decide whether the UK should quit the European Union, some discussion is inescapable.

Setting aside for a moment the arguments surrounding whether Brexit might be good or bad for UK inc. , the first thing to remember is that markets HATE uncertainty ..... and uncertainty is just what they've got, in spades. The decision of some high-profile members of the ruling Tory party , especially the slightly comical but hugely influential Mayor of London Boris Johnson, to come out in favour of quitting the EU leaves the contest looking a good deal more even. Indeed, the Prime Minister is likely to be more than a little miffed with the number of his own MPs prepared to defy his advice to recommend staying in Europe. Exactly how many ? Well, it's hard to tell with so many still undecided and that is likely to be a constant theme in advance of this vote. The issues are complex, even for economists, and whilst there will be a politically motivated core on both sides of the debate, there will be a large body of people unable to decide which way to jump until the very last moment. This makes life pretty difficult for pollsters, who are already held in pretty low esteem after misjudging the General Election so badly. Bookmakers have a better recent record and we hear that they're calling the odds of Britain voting to exit as 2-1 against .... our impression, and it is only an impression, is that it might be closer than that but with so many undecided it would be a mug's game to call it this early.

Anyway, it all adds to the uncertainty we were talking about but beyond that the currency markets have given their view of just what an increased chance of Brexit would mean for a UK that would need generous trade deals from its newly-divorced ex-partner at the same time as negotiating new ones further afield. In particular, some will be asking how the UK will attract enough investment to fund an already huge current account deficit that is running at 4.5% of national output. In a sense they've already given us one answer to that: a lower currency.

As we often say, a cheaper currency is good news for competitiveness and the UK's FTSE 100 equity index managed to post sizeable gains even as the Pound was falling out of bed. Sterling has a history of huge moves in times of crisis and it was even asked on Bloomberg yesterday whether we might see a scenario that resembled that of March 1992 and its aftermath, which saw a tumbling currency and soaring stock markets. Emphatically, the answer is that it's not the same thing at all. You'll remember that was the time when in what seems a moment of utter folly Britain was attempting to defend the Pound's position in the ill-fated Exchange Rate Mechanism through foreign exchange intervention (that cost billions) and high interest rates. When the UK authorities finally ran up the white flag, the pound crashed (of course) and equities did indeed start their march higher  --  but then, that was due to prolonged relaxation of an interest-rate regime that had been forced well into double-figures (briefly 15% on the day of the collapse) in order to defend indefensible currency levels. Plainly, comparisons with the current situation would be misplaced.

We'd say that so far a majority of economists and business leaders support Britain staying in the EU, but that does not mean that there aren't plenty of respected names who take a different view. So it's asking an awful lot of Joe Public to decide which route might be best for him and his family if even the experts are split on the issue. Britain and its place in the EU has long been an issue of politics and sovereignty alongside the more narrowly commercial concept envisaged by the UK leaders at the time of Britain's entry in the 1970's. The inability to discern which choice would be the more economically beneficial to the voter will mean that these more abstract notions will play a bigger part in the decision-making process, and make it that much harder to predict. Frankly, this could go all the way to the wire. Expect plenty more uncertainty, and volatility to go with it.

And since we mention politics, it might just be worth considering what the future might hold for the ruling Conservative party. If the vote is to leave, Prime Minister Cameron's position would surely be untenable and he would be forced to stand down pretty swiftly, in which case presumably Mr Johnson would be favourite to take over leadership of the party. If the vote is to stay, he'll stay too but he is adamant that he won't seek a third term as PM ..... which means the Tories will have to unite to elect a new leader after a period likely to be marked by some pretty unpleasant in-fighting. The opening salvo from the usually rather urbane Mr Cameron to his old friend Boris Johnson was surprisingly vicious.The Conservative Party has form when it comes to tearing itself apart, usually over the issue of Europe. Might they do it again ? And if they do, is it even possible that the old-fashioned, unreconstructed left-winger Jeremy Corbyn might find himself in with a shout of leading the Labour Party to success in the next election ? It's not as unthinkable as it seemed just a short while ago, though just imagine what the markets would do to Sterling if that scenario should come to pass.