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Brexit Scenarios: The good, the bad and the ugly – HSBC

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Mar 11, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    Simon Wells, Chief UK Economist at HSBC, suggests that armed with a measure of uncertainty, its potential impact on GDP and what the policy response might be, they outline three ways in which the economy might be impacted in the event of a vote for Brexit.

    Key Quotes

    “These scenarios help frame some of the key factors that might impact the near-term economic outlook.

    Scenario 1: Markets and businesses take the vote in their stride

    Suppose we are wrong about uncertainty spiking in the event of a vote to leave. After all, the UK would remain a flexible and dynamic economy. Markets and firms might simply assume that a free-trade agreement with the EU would be reached, regardless of the type of exit. In this case, any uncertainty-related fall in investment might be offset by a rise in consumer confidence – after all, the majority of British people should be happy as they would get the change they voted for. This could be compounded by business optimism about freedom from EU regulations. Put simply, in this case, there would be little change in the macro backdrop and the investment implications of Brexit would relate mostly to sector-specific factors.

    Scenario 2: Uncertainty spikes

    In the event of a vote for Brexit, our base case would be that uncertainty spikes temporarily, to a level of around two standard deviations above its mean. Although this assumption is arbitrary, such a level is rare but would entail considerably less uncertainty than at the height of the global financial crisis. Although this would be a huge event for the UK and perhaps the rest of Europe, the uncertainty would not be as severe as when many feared the world was heading for another Great Depression. A rise in our uncertainty index from its current (below average) level to around 2 standard deviations above its mean would suggest a Brexit vote could take around 1-1.5pp off the GDP growth rate in H2 2017.

    Scenario 3: Uncertainty stays elevated and causes capital flight

    In this scenario, uncertainty would stay elevated as there is no clarity on what an EU exit entails and 'divorce' negotiations proceed slowly, which weighs more heavily on GDP. This could cause overseas investors to reduce capital inflows, meaning the current account deficit would put further pressure on the currency. To head off a bigger rise in inflation and stop capital outflows, the BoE might in this case be forced to raise interest rates. The net result is that the UK would fall into recession, alongside a period of relatively high inflation.”
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