On June 23rd, voters in the United Kingdom will consider a referendum on whether or not the nation stays a member of the European Union. Opinion polls report that decided voters are about evenly split between remaining and leaving, and the undecided share is still in the low double-digits. Our baseline is predicated on the assumption that the “remain” campaign wins, but we assign only a six-in-ten probability to that outcome.
While the inference is not obvious, we believe that financial market prices incorporate a higher probability of the U.K. remaining in the EU than we do. If so, the realization of that event should not move markets beyond the resolution of some uncertainty.
The chief beneficiary of taking a major event risk off the table should be the exchange value of the pound, which has probably softened a bit on referendum rue. A stronger pound will not be much of a headwind to UK economic expansion or drag on inflation. This puts the Bank of England back into the game, and we expect them to firm their policy stance modestly by the end of the year. The European Central Bank no doubt welcomes currency weakness against trading partners--and the UK makes up about 10 percent of bilateral trade. Still, given the headwinds facing the ECB, a little weaker euro offers only slight relief and their substantial accommodation will remain in place. The Federal Reserve will have one less reason to delay modest policy tightening this year.