BREXIT

With the EU referendum now confirmed for June 23^rd, the stage is set for 4 months of uncertainty and debate about what Brexit would mean for the UK. The decision by Boris Johnson to campaign for an exit has clearly given the Leave camp a lift and has probably increased the chances of a very tight race.  Currently, the polls are leaning towards staying in but there are a large number of undecided voters and this means that events in Europe leading up to the referendum could play a crucial role.

In terms of the market impact, the clear loser from the uncertainty will be Sterling and the currency has already seen a sharp reaction, dipping below 1.40 versus the US Dollar. This is understandable as no one is quite sure what would happen once the UK left the EU, how easy it would be to renegotiate access to the single market or how multinational companies based here would react. Further falls in the currency are likely if the polls are close, with some investment banks forecasting 1.15 versus the Dollar if Brexit were to happen.

The impact on gilts so far has been limited and that will probably remain the case for the time being. The truth is that Brexit is only one of many factors driving bond markets at the moment, with worries over China and a slowing global economy being the more dominant concerns.  In terms of possible bond market hedges though, index-linked gilts could do quite well if Brexit happens because a sharp fall in Sterling will almost certainly give a strong boost to inflation.

UK equities have so far reacted with a shrug and we think that makes perfect sense. While some domestic companies may be adversely affected, a large part of the FTSE 100 is made up of international businesses who receive much of their revenues from overseas and in foreign currency. In fact, a weak Sterling may be an advantage for them as it will increase the funds available to pay dividends, an important topic in equity markets at the moment.

Written by: Richard Carter – Fixed Income Specialist, Quilter Cheviot