09 February 2015

ING: Ready for Brexit?

Real risk that the UK leaves the EU

The UK’s future relationship with Europe will be a key issue at the May 7 General Election. David Cameron has promised to hold a referendum on the UK’s membership of the European Union (EU) by the end of 2017 if he remains Prime Minister. With opinion polls suggesting that, firstly, the election will be incredibly close and, secondly, there is little enthusiasm for the EU among the British electorate, there is a very real risk that the UK leaves the EU.

Two years of uncertainty

If a referendum is called there will be two years of uncertainty ahead of the actual vote that may unsettle businesses and households. The economy will likely lose some momentum and the BoE may raise interest rates more cautiously. As we saw with last year’s Scottish Independence vote, foreign investors may take fright with UK asset prices and sterling likely to come under downward pressure. UK GDP growth in 2017 could be half a point lower, irrespective of the outcome of the vote.

Vote to stay

Should the UK negotiate a stronger deal with the EU and vote to stay, there could be a substantial bounce back in growth (3.5%+ in 2018) as delayed investment projects are finally implemented and confidence returns. UK asset prices will rebound.

Vote to leave

Should the UK vote to leave, Brexit raises clear risks for trade and investment and, by implication, growth and jobs. 2018 GDP growth could be sub 1.5%, GBP/USD would likely drop below 1.40 and the Bank of England may loosen monetary policy. This outcome could also reignite the campaign for Scottish Independence.

A trade deal will need to be agreed very quickly and bi-lateral deals agreed with non- EU countries. This should be relatively straightforward, but foreign investors will remain nervous. As the situation stabilises in 2018, growth prospects should improve, helped by weaker currency and low interest rates. The UK’s longer term prospects will be driven by what it can do with its new found “freedoms”.

The loss of the UK – a relatively fast growing economy that is on course to be larger than Germany in the next 20-30 years – would negatively impact the EU’s own economic outlook and global influence. The loss of the UK’s more laissez faire influence could also upset the political balance within Europe.

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