On 23 June 2016 the United Kingdom voted, by a slim margin of 52% to 48%, to leave the EU. This is an unprecedented event that immediately impacted global financial markets and now affects negotiated global trade deals. What’s next and how does this affect us in the southern hemisphere?

searching for insights

What is the EU?

The European Union (EU) began five years after World War II ended, when France and Germany devised a plan to maintain peace and foster economic co-operation. The thinking was: countries that trade together are less likely to war against each other. The resulting deal was signed by six nations who pooled their coal and steel resources in 1950.

It grew to become a ‘single market’ in 1992, where goods, services and people move freely, as if it was a single country. The EU’s own currency, the euro, has been adopted by 19 of the member countries.

Today the EU is an economic and political partnership between 28 European countries, with a total population of more than 500 million people. There are four key institutions that work together to run the EU’s political and economic bureaucracy – the European Commission, the European Parliament, the European Council and the Court of Justice.

Why isn’t the EU working for the UK?

The EU requires common laws to ensure products are made to the same standards with various rules to help ‘level the playing field’. With much of their national decision-making process removed, it’s seen as undemocratic and unaccountable to the public; which raises the issue of sovereignty. “Who governs you?” is the most important question for any population.

Regulations and bureaucracy are seen as being excessive and too expensive for the British economy to sustain. According to Treasury figures, after funds for development returned to the UK, their net contribution in 2015 was £8.5bn, approximately 12.6% of the EU budget. Incidentally, Germany paid the largest share at 21.36% followed by France at 15.72%.

Many believed Britain was being held back by the EU, and generated little return in exchange for the money it paid into the system.

Mass migration from poorer countries has raised questions about the free movement rule. In 2015 the UK had a net migration of 330,000 people, with a slight majority coming from outside the EU.

Between 1993 and 2014 the UK’s foreign-born population more than doubled from 3.8 million to around 8.3 million, with foreign citizens increasing more than 3 million in the same period. This immigrant influx led to a major spike in anti-immigration sentiment, with 77 percent of Britons believing that immigration levels should be reduced.

What brought Brexit to a head?

There has always been a faction within British politics that’s been skeptical of a deep integration with the rest of Europe. This was reinforced during the global financial crisis and ongoing poor performance of the European economies. If you thought the post-2008 recession was bad in the US, it was almost apocalyptic in the EU. This was because a number of EU nations embraced austerity measures.

Central banks normally increase money supply during recessions but in 2011, the European Central Bank raised interest rates, tipping the eurozone into a double-dip recession. Greece illustrated how exposed the Eurozone was, and what could be in store for other countries.

At a grassroots level, most people in Europe feel more loyal to their own countries and resent the amount of power that Brussels exerts over their lives.

Other events, such as the ongoing Syrian refugee crisis, have put even greater pressure on the EU’s resources.

In 2012, after three years of the Eurozone crisis, Prime Minister David Cameron was under pressure from his own Conservative party to hold a referendum, now known as Brexit. Conservative legislators passed the bill to hold a vote before December 2017.

The most common arguments for Brexit were:

  • The EU threatens British sovereignty
  • The EU is strangling the UK in burdensome regulations
  • The EU entrenches corporate interests and prevents radical reforms
  • The EU was a good idea in theory, but the euro is a disaster
  • The EU allows too many immigrants
  • The UK could have a more rational immigration system outside the EU
  • The UK could keep the money it currently sends to the EU.

The intellectual case for Brexit centred around economic regulation and political sovereignty, whereas the political argument – which was targeted at everyday Britons with force – was based on the emotionally charged liberal internal migration rules.

With a few exceptions, big business was in favour of Britain remaining in the EU, as it’s easier to move money, people and products.

This all led to a historic vote on 23 June 2016

The referendum saw Brexit win with 52% versus 48%. Turnout was a massive 71.8%, with more than 30 million people voting. Scotland and Northern Ireland both backed staying in the EU.

Here’s the age split of voters:

  • 18-24: 75% voted Remain
  • 24-49: 56% voted Remain
  • 50-64: 56% voted to Leave
  • 65+: 61% voted to Leave.

It’s interesting to see that UK’s new tax base voted to Remain, and will have much longer to live with the decision of their elders.

Racism attacks on the rise

Post-Brexit, racial abuse has been on the rise, with Muslims and the Eastern Europeans being targeted the most. The Police treat these as hate crimes.

What does the future look like?

There’s no precedent for a country leaving the EU, so this won’t be a straightforward process.

The EU is questioning whether the margin is wide enough to be a legally binding decision based on EU regulations, and is discussing whether it can force a second referendum. They also know that Brexit wasn’t a legally binding referendum.

The decision has not yet been ratified by Westminster and London hasn’t submitted the formal departure process to Brussels. Prime minister Cameron said he would leave this to the next leader when he steps down as PM in October 2016.

But should the British invoke Article 50 of the Lisbon Treaty (which sets out exit rules), the parties have two-years to negotiate a deal. If no deal is negotiated in this time, the UK’s membership in the EU would automatically expire.

At issue is whether any EU treaties and laws would continue to apply to the UK after it leaves. Until then, the UK will continue to abide by these, but not take part in any decision-making.

Britain could negotiate a deal with the EU, similar to Norway’s. They’re not a EU member, but voluntarily agreed to abide by most EU rules in exchange for most of the benefits of EU membership. So British businesses could in theory be granted the same preferential access to the EU that they enjoy now. However, EU members have already expressed that Britain can’t cherry pick the best parts of the EU.

At stake is half of the UK’s trade that occurs with the EU, and trade deals with a further 60 countries which are governed by agreements the EU has negotiated. However, trade and investment flow both ways. The UK is the second largest economy in Europe and the fifth largest in the world. Outside the EU, Britain would be free to sign other trade deals with the likes of India and China.

Brexit places the EU at a crossroads. We could either witness a domino effect where other countries opt-out of the EU, or the EU will become even closer.

The Scots may press for a new independence referendum, and if successful, will seek to join the EU. Northern Ireland could follow suit. British businesses with substantial EU interests might then relocate from England to Scotland.

What are the markets doing?

Following Brexit, the British pound dropped 8% after the first trading day. This took the pound to its lowest value since the 1980s. The UK government estimates that exiting the EU could reduce the British economy by up to 7.5 percent by 2030. Yet, global financial markets appear to be mostly shrugging off the Brexit result, with almost all major markets recovering their post-Brexit losses.

However, currency markets point to choppy waters ahead for the British economy; the unwanted result for our exporters being the boosting of New Zealand’s currency. The kiwi is currently trading around 53.96 British pence, and is also up against the Australian and US dollars.

New Zealand’s Finance Minister Bill English insists that NZ is better placed than most countries to manage the decision of British voters. He said New Zealand was comparable with countries such as Iceland, South Korea and Australia and had a “combination of reasonable government finances, a reasonable growth path, and room for interest rates to move.”

NZ Traders believe the Reserve Bank will cut the official cash rate to 2 percent from 2.25 percent on August 11.

There’s still a lot of uncertainty, but overall the market appears to be tracking for a positive outcome. These are interesting times, which we’re following at Fifo Capital. Overall, we think it is business as usual and agree with the NZ finance minister, that our economy will be relatively protected.