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Brexit Vote: What could it mean if the UK votes to leave the European Union?

| July 05, 2016
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The stock and bond markets have been gyrating from losses to gains based on the results of a series of successive polls out of the UK. The question is whether the referendum scheduled for Thursday, June 23rd will result in the UK leaving the European Union (EU), or not. 

Recent polls show that the results of the referendum will likely be very close with the latest polls giving a slight edge to the “no” vote, meaning the UK will remain a member of the EU. However, the polls have fluctuated greatly in the past several weeks making the results uncertain.

The UK is a member country in the EU but opted out of the currency union. Therefore, the UK still uses the pound rather than the Euro. However, the UK is subject to other EU rules related to the level of government deficits, allowing migration between member countries, and conforming to trade agreements both between EU countries as well as other countries that have trade agreements with the EU. Should the UK choose to exit the EU it would gain more flexibility when it comes to fiscal policy as well as trade and migration policy. However, it would also weaken its connection to the European Continent by potentially making travel and business arrangements more cumbersome.

From polling data it appears that the primary reason that UK voters support the “yes” vote to leave the EU is migration policies. Many UK voters do not like the EU policies that allow citizens of member countries to freely migrate between member countries, much like the free migration between states in the US. Much of this is prompted by security concerns as refugees are taken in by many EU member countries which could give the refugees the ability to migrate to the UK under existing rules.

So why are the global financial markets so focused on the Brexit vote?

There are three potential answers to this question, ranging from the short-term implications to longer-term implications. The first is that a “yes” vote could cause the value of the pound and UK gilts (UK government bonds) to decline. This could cause investors with holdings in UK stock and/or bonds to experience short-term losses. Therefore, investors may be incentivized to sell before the vote in order to preserve the value of their investments.

The second is that a “yes” vote will force the UK to renegotiate its trade policies with EU member and non-member countries. This creates uncertainty about the profitability of businesses that engage in high levels of trade with the UK. In general, investors dislike uncertainty. So a vote to leave the EU could reduce the risk appetite for UK domiciled investments as well as investments that are linked to the UK through trade channels. However, it should be noted that the primary reason for the movement to leave the EU has been migration policies, not trade policies. Therefore, trade agreements may change very little in response to a vote to exit the EU.

The thirds is that a “yes” vote may encourage other EU nations to consider leaving the EU as well. The past seven years have shown that the EU experiment has produced a number of winners, such as Germany, as well as a number of losers, such as Greece. If the UK is able to exit the EU without any major negative ramifications it may support the movements if other member countries choose to leave as well, in order to gain more autonomy over their fiscal and trade policies. This could lead to a large amount of uncertainty and instability in Europe as well as the major EU trading partners, such as China.

Whichever way the vote on Thursday goes, it will likely result in increased volatility in European markets. The fact that a large member, like the UK, is considering leaving the EU with such a close vote is likely to be destabilizing for the region as a whole. 

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