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What do traders need to know about the UK’s EU referendum?

On Thursday 23 June UK citizens will decide whether they wish to remain part of the European Union or not. The matter will be settled by a nationwide referendum which is already generating high levels of anxiety in the financial markets. The FTSE 100 index and sterling are directly impacted by the issue of ‘secession’ from the European Union.

The big questions each trader should ask are: what would a Brexit look like? How would a Brexit affect the performance of the GBP, the FTSE 100, the CAC 40, the DAX 30, the Nikkei 225 and major averages on Wall Street? And how would a Brexit affect my own financial portfolio?

Key facts about the UK-EU relationship

  • The EU comprises 28 nations which share political and economic success or failure
  • The EU also plays host to the eurozone with its 19 members of a common currency
  • The UK is a member of the EU but not of the eurozone
  • The UK contributed $17.4 billion to the EU during 2013, up $13.6 billion from 2008
  • Many UK citizens are angered at having to spend so much money propping up the bureaucratic system in Brussels as opposed to infrastructure development in the EU
  • The UK is split between those who support the flow of migrants from Eastern Europe into the UK, and those who fear the migrants are taking jobs from UK citizens
  • UK opponents of remaining in the EU cite ‘welfare tourism’ of migrants regarding healthcare and unemployment benefits
  • Proponents of the status quo believe the EU is the best trading bloc to partner with and there are untold economic, political, social and other benefits to be gained, including better trading terms with other nations and free trade within the EU

What benefits did David Cameron achieve at the recent EU summit?

PM David Cameron wanted Britain to be excluded from European Union treaties that entice member states to move closer towards union – he achieved this objective.

He also wanted a ban on paying in-work benefits to migrants from the EU who are in the UK – he partially achieved this objective by way of convoluted agreements, but Tories will likely be unsatisfied with his negotiated settlement.
Crucially, Cameron wanted the UK to have greater autonomy when it comes to challenging EU regulation – he achieved this objective since the UK can challenge decisions in European courts if it feels that they discriminate against the UK.

How would a Brexit impact on your financial portfolio?

If the UK votes in favour of leaving the EU, there will be far-reaching ramifications for equities, commodities, currencies and indices. The euro and the pound will be first in line to take a hit, as the absence of the UK heralds greater instability for the EU. Likewise, the absence of the economic clout of the EU will add further stress to the UK economy.

The short and medium-term impact of a Brexit would rock financial markets, but it’s the speculative sentiment in the lead-up to the referendum that will be characterised by high levels of market volatility, particularly in the FTSE 100 and the pound. Already, the GBP/USD pair has hit multi-year lows, and this impacts on the profitability of UK exporters. Lower revenue streams lead to declining profits and lower share prices on the LSE. Equities will invariably feel the pinch and this goes for financials, industrials, healthcare, technology, and other stocks across the board.

A Brexit would hurt European equities and the euro accordingly. We would likely see the euro and sterling trade lower against a basket of currencies including the Japanese yen and the US dollar. As a trader, in this scenario you would want to take long positions on the greenback and the yen, and short positions on the euro and sterling.

Possible scenarios

If UK citizens vote in favour of staying with the EU, calm should return to the markets and sterling should appreciate sharply alongside UK indices. Markets do not react well to disruptions and that is precisely what a Brexit represents. EU bourses should also enjoy a bull run if the UK votes to stay as part of the EU.

If UK citizens vote in favour of leaving the EU we would likely see the opposite effect: sterling and UK equities would be adversely affected as would the euro and European bourses. This would have a ripple effect on all the countries the EU trades with and the associated currencies. Emerging market economies would likely take a pounding as uncertainty would drive a wedge between EM currencies and leading global currencies.

A poll by the Financial Times in early January 2016 showed that 75% of the 100 economists polled feel that a Brexit would harm the UK over the medium term. While some believe the UK economy could soar without the protectionist measures of the EU, many believe the UK economy could plunge sharply following the instability of leaving the EU and could enter into a period of recession or slow growth relative to its European trading partners.

Brett Chatz

Published: 26 February 2016

You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.

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