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Macroeconomics

04 March 2016

The Brexit Threat 

Some may see the euro as a relative safe haven if sterling starts to run into serious trouble ahead of the June 23 referendum on the UK’s membership in the European Union. However, the British decision will have material consequences for the rest of the EU, leaving the euro vulnerable in a number of respects.

If the UK votes to exit, the common currency will not escape unscathed.

Some four months ahead of the referendum, UK popular opinion appears very closely divided. The risks for the UK in the event of an exit vote are writ large, and the country’s very sizeable current account deficit undoubtedly leaves sterling vulnerable. The risks for the rest of the EU, especially over the longer term, may also prove significant.

From an economic perspective, the UK is a major trading partner. It was the EU’s single largest export destination and import source from 2008-12 – though this is partly due to the role of Rotterdam as a conduit for global trade.

Accordingly, the large-scale renegotiation of bilateral trade agreements, triggered by a UK exit decision, would negatively impact both the UK and the remaining 27-nation bloc.

The political consequences could be even more damaging.

The UK’s departure from the EU creates an exit door through which other countries could follow. The single most important driver of anti-EU sentiment in the UK is immigration, which is also a major concern across much of the continent. A UK exit, reflecting public anti-immigrant sentiment, would advance the case for similar referendums in other EU countries, creating a possible domino effect. 

Denmark and the so-called “Visegrad Four” nations – including the Czech Republic, Hungary, Poland and Slovakia – are among the countries most likely to face exit pressure.  

The UK’s departure from the EU would also disturb the delicate balance of power that lies at the heart of Europe.

The three major political powers – the UK, France and Germany – each provide a very different impetus to this complex dynamic. Absent the “common enemy” of political integration, it would appear to follow that the EU would be more politically cohesive. 

However, it’s also possible that member states, even more worried about the influence wielded by Germany and France, could redirect their political energies towards jostling for power and position. Indeed, it is possible that a post-Brexit EU could prove less, not more, politically cohesive. 

Either way, at the very least, this event would usher in a period of uncertainty about the nature of the new political dynamic at the heart of Europe. 

Versus a vulnerable sterling, there appears to be considerable upside for the euro, and we remain fundamentally positive about the outlook for the common currency. However, we recognize that the UK referendum also presents significant downside risks, threatening to unsettle the EU from both an economic and political perspective, irrespective of the decision on June 23.