Saker Nusseibeh on the EU referendum vote and potential ‘Brexit’

Saker Nusseibeh, Chief Executive, Hermes Investment Management:

“It seems to me that the debate around Brexit revolves around three distinct axes, each of which offers somewhat different outcomes for each side of the campaign.

“The first, the emotive heart of the leave campaign, centres on the question of sovereignty and specifically the right of Britons to exercise their will through Parliament without subjugation to laws administered by a supra-national authority in Brussels, which they did not elect. While some might still remember the issue of what a banana should look like, and seemingly endless regulation, the emotive heart of the argument to leave the EU has gained national sympathy in its appeal to citizens to uphold the right of the Home Secretary to expel individuals from British soil who may pose a danger to our security without any challenge from a foreign Court of Human Rights, regardless of the fact that said court and convention were imposed on post-war Europe by Winston Churchill, it is clear that on this issue that leaving the European Union will allow Britain, if it so chooses, to completely ignore the European Court of Human Rights it set up in 1948.

“The second axis revolves around immigration. Here two separate arguments seem to be intertwined. The first is based on what Archbishop Welby described as the legitimate fear felt by Britons of migration, and particularly the mass political refugee migration emanating mostly from North Africa and the Middle East. In this, the case for the Leave Campaign is equally correct. If Britain were to leave the European Union, it can close its borders and limit itself to the 20,000 refugees the government has agreed to accept by 2020, although it seems the vast majority of that flood is being absorbed by Turkey (3 million) and Germany (1 million).

“The second argument is to do with the economic immigrant wave coming from Eastern Europe (some 1.9 million workers in the UK were born elsewhere in the EU). Here the case is less clear cut for the Leave Campaign. The fact that unemployment in the UK stands at 5.1%, one of the lowest rates in developed economies, suggests that these workers are not displacing native born workers. However, the fact that underlying wage growth is running under 2% suggests that this influx has forced down wages, which is good for cost control and therefore for inflation. However, this is painful for low-income UK citizens that see their income eroded. Moreover, with austerity in full swing, the growth in the working population and their families is clearly putting strains on the resources of the social state, including the NHS and the education system.

“However, the problem is that in most scenarios, leaving the European Union will not enable the UK to reverse this trend in any meaningful way, because any trade agreement with the EU will still have to entail some form of free movement of labour. Therefore, it is difficult to see how the Leave Campaign can achieve its objective as it relates to the majority of the immigrant flow into the UK.

“The third axis revolves around the economic benefits of being in the European Union against the cost of £8-10 billion net contribution the UK makes each year to the EU. In this part of the argument, it seems to me the weight of evidence stands with the Remain Campaign. Some 44% of UK goods exports are to the EU, possibly 42% taking into account the Rotterdam effect. This percentage has fallen from 60% with the slowdown in European economies over the past few years, but it is likely to rise again in time.

“On the other hand, the UK imports heavily from the EU, and the argument is that this interdependency means a trade deal could be reached. However, with the dominance of the City, the UK is a net exporter of financial services. The dominance of the City will most certainly decline dramatically in the case of a leave vote as it is unlikely that Europe will continue to allow Euroclearing to take place in the UK (a non Euro area) post leaving, resulting in a deterioration of the City’s world dominance in Forex.

“Therefore, on balance, a rational assessment would see limited gains from a vote for an exit (sovereignty over political expulsions, a limiting of the already small number of refugees taken by the UK but little stemming of the EU-sourced migration) set against the probability of economic harm to the UK and a smaller possibility of severe global harm. Practically there is a very real possibility that the initial competitive gains from a sterling depreciation could turn into an ERM-style route with interest rates rising rapidly and the outside chance of a 2008 repeat.

“The truth, however, is that the vote on the 23^rd is likely to be emotive, not rational, and wise investors must therefore brace themselves for severe economic headwinds in the months to come.”

The views and opinions contained herein are those of Saker Nusseibeh, Chief Executive, and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products.