From the graph below, one can see that the uncertainty created by a potential Brexit has already created a significant drag on the British economy. The British stock exchange FTSE 100 is down by almost 10% from a year ago. Furthermore, the uncertainty created by the vote has also contributed to increased market volatility in recent months.
- The pound will drop immediately, maybe by as much as 2% on the same day, 2-4% in the same week and u to 10% in the next 3-6 months.
- British stock prices would drop immediately. A 4% decline within the same week and a 10% decline within the next months would not be out of the ordinary for such a negative shock. European stock prices would fall as well, albeit not as much.
- British bond prices would probably rise implying a lower yield, as investors seek safe havens. The same applies to European bond prices, which might move even further into negative territory because of a flight into safety.
- The British central Bank might respond to the economic slowdown by cutting interest rates within the next months, maybe even going all the way to zero. This, of course, would put further downward pressure on the pound.
- Concerning the long-term effects, the IMF has estimated that UK output could fall by about 2-5% (relative to the baseline of no Brexit) if the country was to leave the EU. This would be a substantial loss. There are very little economic policies that could decrease (or increase) a country’s GDP by 2% in perpetuity.
Conversely, if the vote outcome will be remain, we should obviously expect the opposite market reactions. British and European stocks would raise while bond prices might actually fall. Furthermore, the British pound would appreciate. In fact, we already see a slight appreciation today, indicating that financial markets don’t expect a Brexit to happen.
To sum up, a Brexit would be a significant economic shock to the UK economy, ranging from bad to pretty bad. From an economic point of view the decision should be a no-brainer. Don’t leave, and don’t panic!