European Central Bank

While the draft agreement delivered by Donald Tusk may have bought us one step closer to an EU referendum, it certainly hasn’t calmed the controversy surrounding the subject. Commentators have been quick to point out the potential positives and negatives of a Brexit, but when it comes to the impact on the economy, the answers are far from clear cut. With this in mind, we take a look at some of the potential economic outcomes of a UK exit from the EU, and assess their impacts for businesses.

Cutting ‘red tape’

While the draft agreement proposes increased efforts from the EU to cut bureaucracy, especially on small and medium enterprises, competitiveness remains a bone of contention for Eurosceptics. There’s a raft of red tape associated with being an EU member; a headache many hope will disappear with a full exit. Less legislation is good news for some UK businesses, as this has the potential to help facilitate more free trade, making it easier to trade with markets outside of the EU.

Continental Europe is, however, currently the UK’s largest export destination. Businesses seeking to continue exporting to the EU will have to continue trading on the EU’s terms (read continuing to apply the ‘red tape’), effectively negating this positive for such businesses. Domestically focussed businesses should indeed benefit, reducing administration costs and increasing productivity.

The predicament is echoed in the services sector, particularly financial services. Leaving the EU could mean reduced regulation, but could also lead to complications. The impact of not being able to offer access to the EU Single Market in financial services can only be a negative for the industry.

A weaker pound

If the United Kingdom were to leave the EU, it is likely that the pound would weaken – at least in the short term. This would be beneficial for UK investors holding overseas investments, as they would benefit from currency gains. A weaker pound would also make UK exports relatively more attractive for overseas consumers.

Interest rate increase

Mark Carney has stated that the Bank of England would raise interest rates in the UK if we were to leave the EU, as investors would demand greater compensation for a perceived increase in, causing consumers to pay more to service debt. With household debt at record levels, rate rises would be sorely felt and again, have the likely consequence of reducing domestic demand.

UK equities

Small and mid-cap equities would feel the impact of a Brexit most acutely, as they are generally less diversified in terms of revenue exposure. Big cap companies will remain buoyant due to generally possessing a wider reach of revenue generation across a broader range of jurisdictions. However, while small and mid-caps are due to feel some immediate turbulence, once the market has settled, they should benefit from a reduction regulation, and could actually increase their profit margins in the medium to long-term.

No matter the outcome – which is still too close to call – the fact that a Brexit is even on the cards is causing additional volatility, and already causing investors to demand a risk premium for UK assets. With instability the only certainty over the next few months before a potential June referendum, investors would be advised to brace themselves and diversify their portfolios, both across asset classes and also jurisdictions.

By David von Dadelszen, Director at UK Bond Network