EU vote casts shadow over Britain as 2016 kicks off

January 8, 2016

At this stage, it is hard to quantify how a planned referendum on Britain’s membership of the European Union is impacting investor sentiment and the outlook for business investment. But there is little doubt it will influence the timing of the Bank of England’s first interest rate hike in nearly a decade and how sterling trades this year.

If a referendum were not taking place, improved economic fundamentals would lead the BoE to raise rates at the start of the second half of 2016, according to Societe Generale’s head of investment strategy Alan Mudie. That would be about half a year behind the U.S. Federal Reserve, which just raised its federal funds rate from a record low last month.

But Mudie says the EU vote pushes that call further out to late Q3 or early Q4. That is later than the consensus from a Reuters poll of economists who expect a rise in the second quarter. Financial market pricing suggests a Bank Rate rise around the turn of the year at the earliest.

If Britons voted to leave the EU, British interest rates would stay at a record low of 0.5 percent certainly past the end of this year, Mudie said.

That possibility is also likely to weigh on sterling this year, which has already been beaten down to a 5-1/2 year low against the dollar this week below $1.46 and to a six-week low against the euro. The pound could fall below $1.40 should opinion polls start showing more people in favour of an exit, he said. Societe Generale estimates that a decision to leave the EU would cut British growth potential by 0.5-1.0 percent per annum over the coming decade.

Public opinion polls show the gap between the pro- and anti-membership camps is narrow, with a significant number of voters undecided.  A recent poll showed a majority of Britons who have made up their minds would vote to forego EU membership.

But Mudie expects sterling to end the year just below current levels of 1.46 versus the dollar, betting that the British people will vote to stay. Foreign exchange strategists in a Reuters poll forecast sterling will rise to $1.50 against the dollar in a year’s time. A majority of them said they thought the biggest risk to their forecasts was the lingering uncertainty ahead of the referendum.

Citi analysts say it is the biggest risk to Britain’s economy:

A vote for Brexit would probably cause a major political crisis and significant economic weakness in the UK.  If this risk is averted, the UK in coming years probably will, for the first time in decades, combine sub-5% unemployment and low inflation on a sustained basis.

 

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