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Chief Executive Saker Nusseibeh and Group Chief Economist Neil Williams respond to a clear ‘Leave’ majority vote

27 January 2017

Saker Nusseibeh, Chief Executive:

With the vote decided yesterday, we now have to move away from the rhetoric that typified this campaign. Prior to the referendum, we ran several scenarios on our strategies, and we are reasonably confident that they were well positioned for a Brexit vote in the short term.

However, we are watching market moves very carefully to assess the degree of contagion, if any, to global markets. Besides a sharp sell-off in risk and in sterling, as well as a recession in the UK (which is expected) our fear is that this may trigger political uncertainty within Europe which in turn may lead to a severe global market correction.

In any case, we know that we are now in an even more prolonged super low interest rate environment outside of the UK, with the US likely to delay its decision to raise interest rates even further out.

Throughout, our main purpose remains to help our beneficiaries retire better. Our commitment to our beneficiaries from Europe remains completely undiminished and it goes without saying that our business model had always assumed that we would continue to abide by all EU financial regulations.

One final thought perhaps; it is now incumbent on everyone in the financial sector to work to try to mitigate the risk to our beneficiaries created by politics.

Neil Williams, Group Chief Economist:

Eyebrows are being raised across the City of London. The UK’s vote to ‘leave’ provides a massive ‘curve ball’ for financial markets, which now need time to assess the policy path that a likely, new political line-up will eventually choose to go down. All of this will take time.

Equities and the pound may remain vulnerable given the likely hit to UK growth, and risk now of weaker ties with our main trading partner, FDI foregone, and a diluted relationship with the US and other third parties that use the UK to access the Single Market.

The UK economy will of course ‘survive’, given its entrepreneurial flair, increasing focus on non-EU trade, and likely policy accommodation by the Bank of England and UK Treasury. However, getting to the next stage looks a long, drawn-out ‘can of worms’, leaving considerable uncertainty for UK assets and markets. The extent of this damage now rests on the manner of the exit.

The mark-down on assets would surely be greatest in the case of a ‘hard exit’ – entailing an acrimonious departure, lower trade, lower migration, and recession – than the more probable ‘softer’ version.

But, even a ‘soft exit’ to a Norway or Switzerland-style associate membership will probably need several years just to end up close to ‘square one’. Greenland’s soft exit in 1985 had taken three years. We, larger and 43 years entwined in the European project, will need even longer.

Spillover to Europe…

And, the spillover of exit-risk onto the doorsteps of other European governments may mean little sympathy from them in securing a ‘no strings’ UK deal. With the exit ‘trapdoor’ opening today, voters in EU countries facing big elections – Germany, France, Spain and potentially Italy and The Netherlands – may wish to approach it.

In the eyes of markets, this could erode the safe-haven status of the EU itself, and (together with the ECB’s QE) support the US dollar. If sustained, this offers an additional brake for the US Federal Reserve to ‘peak out’ early on raising US rates.

By voting to leave, we also risk tarnishing the UK’s vital financial services sector with all the macro, ‘passporting’ and regulation risks that Brexit threatens. Financial services has been the heartbeat of the UK’s recovery, providing disproportionate trade benefits, employment, and tax revenue.

The City of London has more than most to lose from Brexit, given its status as a global centre, gateway to the EU, and dominant force in clearing European financial markets. Given its strong starting point and comparative advantage, Brexit may not prove a complete ‘disaster’ for London – but it’s a risk we did not need.

The challenge now is to try to remain at the European negotiating table to secure the best possible trade and regulatory deals for the services sector as a whole. Services represent as much as 80% of the UK’s gross value added.

Other hurdles…

Other hurdles include political uncertainty – given today’s leave vote probably makes it difficult for PM, Cameron, Chancellor Osborne and Foreign Secretary, Hammond to continue. Their successors, once found, may then be left to preside over a fragmenting and potentially smaller UK, as Westminster now needs Brexit ratification from the devolved, regional governments, like Scotland and Wales.

Whichever route is taken – soft or hard – the deployment of UK civil servants needed to unwind membership risks pushing other priorities, such as infrastructure and environmental issues, down the line.

Macro policy may also be disrupted by today’s events. With his GDP and tax-revenue plans likely to be revised down, the (next) Chancellor may have to forego returning to budget surplus by 2019/20.

The Bank of England will of course be watching to make sure a weaker pound doesn’t pump inflation down the line. But, we doubt its hand will be forced to raise Bank rate, given Brexit’s feared hit to growth. Conversely, it may be loathe to cut rates if sterling is weakening.

In which case, it’s possible that dealing with Brexit, the hit to growth, and any reduced attractiveness of UK gilts to international investors (who account for about one third of the UK’s £1.3trn conventional gilts) from a falling pound may need the BoE to again run QE. Potentially, though, this would intensify the pressure on pension schemes from ‘lower for even longer’ bond yields.

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