MacroscopeUpcoming Brexit vote is a potential black swan and the last thing jittery markets need
British vote on whether to exit the European Union shows that political risk can disrupt
On Monday, sterling, Britain’s currency, suffered its sharpest daily fall in six years, dropping nearly 2 per cent against the dollar after Boris Johnson, the mayor of London and a high-profile figure in the ruling Conservative party, declared his support for the UK’s withdrawal from the European Union (EU) ahead of a high-stakes referendum on the country’s membership of the bloc on June 23.
The threat of a British exit from the EU (or Brexit), currently assigned a probability of more than a third according to JP Morgan, which warns sterling is “extremely vulnerable to capital flight” because of the UK’s reliance on foreign money to fund its large current account deficit, is injecting a large dose of political risk into financial markets, already buffeted by a plethora of concerns ranging from low oil prices to the conduct of US monetary policy.
Politics is now an important determinant of market sentiment
Over the past several years, investors have brushed off political risk - the euro even strengthened versus the dollar in the spring of 2015 when it appeared that Greece was about to be ejected from the eurozone - as central banks’ ultra-loose monetary policies distorted asset prices, desensitising traders and asset managers to all sorts of country-specific risks.
Yet the possibility of a Brexit is likely to unnerve investors far more than was the case during the tense standoff between Greece and its creditors.
For starters, pressure on sterling is unlikely to abate in the run-up to the plebiscite and would increase dramatically if Britain, the world’s fifth largest economy (and second-largest in the EU) and whose capital is a global centre for finance and investment, voted to leave the EU.
On Wednesday, sterling dropped below the psychologically important $1.40 level for the first time since March 2009. Goldman Sachs believes a Brexit would cause the pound to drop a further 20 per cent, taking it to its lowest level against the greenback since 1985.
Secondly, and just as importantly, a Brexit could be the trigger for more severe political and financial tensions in the EU itself - stresses which surfaced during the eurozone crisis as investors belatedly recognised the heterogeneity of a bloc that had been wrongly treated as a homogenous entity.