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By: Oliver Norgrove

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February 23rd, 2016

Can't keep up? Here's the latest on the Brexit

Financial Education

[Estimated time to read: 3 minutes]

At long last, the contest is under way for the UK's decision on whether to stay in, or leave, the European Union.  David Cameron returned from marathon talks with his European counterparts, rosy-cheeked and seemingly enthusiastic at the agreement he reached and has now presented to his government colleagues, and to the British people.

The big questions now facing Britain and, of course, Europe, are: will the Brexit happen?  And if it does, what will happen next?

The market response, as always, is instructive. 

Currency markets reacted strongly, sending sterling to its lowest level for seven years.  If, like me, you think the 'right' level for GBP/USD is somewhere around £1 to $1.60, current levels of £1 to $1.40 seem very low.  At the same time, equity markets continue to rally, with the FTSE up almost 3% at the time of writing.

Does this make sense? 

We think it does. What these two markets may be telling us is that the risk of the Brexit happening is evidently increasing, but the impact on the FTSE 100 is complicated:  a very substantial chunk of the FTSE's earnings come from international companies who happen to be listed in London; and a weaker pound can also make the UK market more attractive by making GBP assets cheaper. 

So… the more the currency weakens, the more attractive those UK-listed companies can appear. In other words rising equities is a result of the falling pound rather than an unexpected reaction to a possible Brexit, while the currency weakness is a good barometer for the likelihood of a Brexit. Very weak current levels of sterling underline the fact that the outcome remains finely balanced. 

The consensus view seems to be that there is a 40-50% chance of Britain leaving the EU – but there is a long time to run until the June 23rd UK referendum and we expect, over the coming weeks, to see much ebb and flow in the arguments. Should the 'Leave' camp gain momentum, expect to see the pound plummet in value, as was seen on February 22nd when Boris Johnson joined the Leave campaign – and we would expect equity markets to change tack and follow them down.  The uncertainty, and the unknowable future of Britain's role outside the EU, will weigh heavily until clarity is restored.

The other thing to watch is the Euro: if the Brexit happens, it could be a disaster for the Euro. This seems to have been ignored by the European leaders who held Cameron's feet to the fire during this weekend's negotiations.  In fact, if Britain leaves, the 'Euro Project' will be at even more serious risk.  A Brexit would trigger a wave of similar referendums from other countries whose populations have grown cynical or disenfranchised by the burden, pace and direction of Europe's integration. The contrary view is that the brake exerted by the UK over 40 years of uncomfortable membership will be removed – and the political drive for ever closer integration could therefore pick up speed. 

For expat investors interested in offshore investing, the weakened pound looks very attractive: not just as a trading opportunity into the currency, but UK assets, priced in sterling, will also look attractive. Expats looking, for example, at UK retirement property should consider the impact of the weakening currency and take advantage.  The same is true of Euro denominated investments, and we would encourage investors to recognise the significant savings they will make by buying into GBP or EUR at depressed levels, particularly when buying with savings in USD or USD-pegged currencies.

We think it is still too early to predict what might happen. But it's a good enough start to recognise that the immediate impact of each day of the debate will continue to play out daily in currency markets. 

About Oliver Norgrove

Oliver Norgrove was previously a Banking and Investments Executive at AES International.