The pound would fall 15%-20% against the dollar. The UK economy in 2017 would grow at only the half the rate currently expected.
Inflation would be above 5% by the end of next year, creating a thumping policy headache for the Bank of England. This is HSBC’s “central case” for what would happen if the UK votes to leave the European Union. Too alarmist? No, it all sounds entirely plausible.
Note that HSBC was making short-term forecasts. The bank’s analysts were careful to state that, regardless of the outcome of the referendum, the UK would remain a flexible and strong economy that would “eventually achieve a strong economic performance in or out of the EU”. The short-term impact, however, could hardly fail to be severe.
Start with the currency effect. Sterling has already fallen 6% against the dollar this year as investors have woken up to the fact that Brexit is probably a one-third possibility. If 33% were to become 100% on 23 June then, yes, a 15%-20% fall for the pound sounds about right. And, after a sudden currency fall of that severity, there would almost certainly be an inflationary effect.
As for economic slowdown, well, what else would you expect? It could take two years for the UK to negotiate its exit from the EU. The eventual terms of trade with big EU countries might turn out to be attractive (Germany would still want to flog us BMWs and fridges, after all) but businesses would delay some investment until they had seen the deal. That is especially so when the backdrop is a slowing global economy. In fact, HSBC’s “severe” scenario, which points to the risk of outright recession, feels more likely than its “benign” version that imagines only a small dip in growth in 2017.
The point to remember is that the UK starts from a horrible position of having a large current account deficit that must be funded by flows of capital from overseas. That is a key vulnerability if foreign investors take fright after a vote for Brexit and demand higher returns to hold UK assets.
Mark Carney, governor of the Bank of England, made the same point last month. “The global general environment has become much more febrile, much more volatile, and relying on the kindness of strangers is not optimal in that kind of environment – and that is the case when you are running a 4% to 4.5% current account deficit,” he said.
Carney and Bank officials, of course, are obliged to stay out of the nitty-gritty of the referendum debate as far as possible. There is no chance whatsoever of Threadneedle Street commenting on, let alone endorsing, projections like HSBC’s. But it is a reasonable guess that its scenario assumptions are broadly similar.
The moral for the leave camp should be obvious: there is no point trying to gloss over the short-term economic shock of a vote for Brexit. If the economic pitch is supposed to be greater long-term prosperity via trade deals with other parts of the world, then at least concede that possible gain would be preceded by definite pain.
Honest outers have grasped the point and talk of short-term remedies, albeit in vague terms. The rest, though, prefer to ignore the problem. They had better have something stronger to say by June because, if the opinion polls indicate a close contest, a proper storm could be raging in currency markets.
Far from reassuring stress tests
Here’s an exam we would all love to sit. Students will not be deemed to have passed or failed, because outsiders might judge the flops’ prospects harshly. One of the trickiest subjects will not be included. And, by the way, some of the pupils from the bottom class will be excused.
Yes, it’s the 2016 version of the European Banking Authority’s stress tests on banks. The big idea this time is that the banks won’t be awarded a simple pass or fail mark. Regulators will instead use the results as “a supervisory tool” in order to avoid the problem of investors demanding that sub-grade banks fill their capital holes quickly. The effect of negative interest rates – the market’s current obsession – won’t be studied. And no Portuguese bank will be included.
It would be wrong to say the EBA’s stress test are a complete waste of time. There is merit in looking at how European banks could withstand “an abrupt reversal of compressed global risk premia” and three other risks. But will any investor be reassured by a process that doesn’t look robust and won’t reach firm conclusions that all can see? It seems highly unlikely. In the current environment for banking shares, that’s a problem.
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