PMC Weekly Review - February 26, 2016

A Macro View – Brexit: Key Questions and Answers

What is Brexit? Simply stated, Brexit is a combination of the words “British” and “exit”, which refers to the possibility that the United Kingdom (UK) will exit the European Union (EU). Although the country joined the EU in 1973, its membership has been debated within Britain since then. In fact, while the principal currency of the EU is the Euro, the UK continues to use the pound sterling (GBP) as its independent currency. Most recently, in January 2013 David Cameron, who has served as the Prime Minister of the UK since 2010, stated that should his conservative party win the parliamentary majority in the 2015 general election the UK government would renegotiate the country’s membership in the EU. On February 20th, 2016 Prime Minister Cameron signed a deal in Brussels which revamped Britain’s membership in the EU. So why are we still talking about Brexit? Because on that same day, the Prime Minister set Thursday, June 23 as the date for the referendum in which Britain will vote on whether to remain part of the EU.

While Prime Minister Cameron maintains that the UK should stay in the EU, other people take the opposing view. You might ask, who? London Mayor Boris Johnson, Justice Secretary Michael Gove, and several other ministers have stated publicly that they support leaving the EU. According to the International Business Times, “around 37 percent of 3,482 adults polled online responded they wanted to stay in the EU, 38 percent wanted to leave and 25 percent were unsure.” And while this sounds like a purely domestic problem, JPMorgan, Goldman Sachs, Morgan Stanley, and Bank of America all delivered six-figure checks to anti-Brexit campaign groups in January.

Why do these companies, or the United States in general, care about Brexit? Because the US-UK economic relationship is strong, and bilateral investments between the two countries are the largest in the world. In fact, according to the Organization for International Investment, in 2013 the UK was the largest foreign direct investor in the US, constituting almost one-fifth of all cumulative foreign direct investment holdings, or $519 billion. On the other hand, according to the School of Advanced International Studies, in that same year US foreign direct investment in the UK amounted to $571 billion. From an investment portfolio standpoint, the UK represents more than 14% of the MSCI ACWI ex-US Index, which is a benchmark for international portfolios. Furthermore, according to MarketWatch, nearly 9% of all foreign profits generated by US companies are derived from the UK, and at least 35% are derived from three major countries in the EU. Although there is not a broad understanding of the economic consequences should Britain exit the EU, this week the British pound/US dollar cross fell below $1.40 for the first time since 2009, signaling concern about Brexit. And on Wednesday, analysts at HSBC said a vote for Brexit would cause the pound to decline an additional 15%-20% against the dollar. With the Eurozone already in a weak recovery mode, investment banks consider the potential Brexit to be a threat to this recovery. In short, while Brexit refers to the possibility of the UK exiting the EU, it could have domestic ramifications as well.

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