How Windy Is It . . . ? Monday, 29th February 2016 – No.168
How windy was it last week?
The only story in papers last week, from the Financial Times to the Wall Street Journal, was the countdown to Britain’s referendum on its membership of the EU; more commonly known as Brexit. This week’s Windy is devoted to the current debate.
The fuse has been lit and we have a little over four months to debate, discuss and decide on the future of the UK and the EU. While the British press has been stirring up public opinion over our membership of the EU for some time, the real issues have yet to be presented to the electorate.
David Cameron firmly believes that the UK’s best position sits within a reformed EU and at the recent EU summit he had an agenda of four key points to get a better deal for Britain:
· Sovereignty: probably the subject closest to the heart of many of the electorate, is the option of opting out of an increasingly closer union, with power for Parliament to veto EU legislation and directives.
· Competitiveness: to have an extension of the single market and a reduction in regulation.
· Immigration: to restrict access to in-work and out-of-work benefits to EU migrants, unless a migrant has been resident for four years.
· Governance: to set out an explicit recognition that the euro is not the only currency of the EU. David Cameron is also asking for safeguards against further financial union being imposed on us and that we will not have to contribute to euro-zone bailouts.
So, what did the Prime Minister achieve?
While the summit was always unlikely to achieve a wholesale changing of the guard, the prime minister did manage to achieve some changes, however for the ‘outs’ this was never going to be enough.
· There was recognition on sovereignty that the UK is not committed to an ever-closer-union.
· There was widespread agreement with the prime minister’s view on competitiveness, whether this actually results in any action is the crucial point.
· Immigration was always going to be tough and probably the toughest part of the David Cameron’s EU reform odyssey. He had to make several concessions, most notably EU members rejected a ban on UK resident EU nationals sending child benefit ‘home’. There was also a compromise on how soon after arriving in the UK new EU migrants can claim in-work benefits.
· Around governance there were guarantees that the UK will not have to fund euro-zone bailouts and recognition that the EU has more than one currency.
So is Brexit a real threat?
The referendum will be a simple binary ‘in or out’ question and as it was with the Scottish referendum in 2014, a majority verdict will be enough. Once considered a tail risk, the risk of Brexit is certainly on the rise. Opinion polls do suggest the outcome is becoming closer, however we would caution against reading too much into individual poll results, as recent history has taught us that they can be a poor indicator.
What are the possible scenarios?
If we remain part of the EU then we are likely to see some form of relief rally in markets, however if we vote to exit the EU, then a sharp sell-off would be anticipated. Longer term effects of an exit are harder to quantify, as it would lead to years of uncertainty; the effects are likely to be large and painful in economic, fiscal and political terms for both the UK and EU. The risks to economic growth is keenest with almost 50% of UK exports going to the EU.
The uncertainty around Brexit adds to the view that the Bank of England will not be in a hurry to hike rates, which has seen markets push the chance of an interest rate rise in the UK out to 2019. How this will effect markets is more difficult to forecast and like any prudent business, we are keeping a watchful eye and a steady hand.
In the most simple terms, as the EU is our largest trading partner it makes sense to want them to be strong. If we were to leave the EU that will make the EU weaker, which is not great from the perspective of a trade partner. By remaining in the EU we make the EU stronger, which is good for the UK.
What are we focusing on this week? All eyes will be on the US as this week is data heaven with manufacturing and services activity, along with the all important employment data for February. Since the Federal Reserve raised interest rates we have seen gusts in the markets and squalls in certain indicators. This week’s data releases will be scrutinised for any signs of weakness. With growth activity, which has been contracting in the US since October, a slowing is expected. However, January’s measure did tick up, albeit by a tiny margin, so February’s measure will be examined in detail. The silver lining for the US is employment, which is nearing ‘full employment’ levels. The current rate of unemployment sits at just 4.9%, the lowest reading since early 2008, so it would have to be a significantly poor result for markets to get rattled at the end of the week.