Brexit effect: what does a vote to leave mean for finances?

European Parliament, Brussels © European Parliament – Audiovisual Unit

The EU referendum is almost here and local government will face implications if Britain votes to leave. Room151’s commentators discuss the effect on interest rates, investments, budgets, business rates and central banks.

Robin Creswell, Payden & Rygel

Robin Creswell
Managing principal at Payden & Rygel

Local government will most likely experience short and medium term effects on their finances if Brexit occurs, with a potential impact to treasury, pension costs and budget finances.

Uncertainly alone, ahead of the referendum, already provides some indication of what might lie in store.   At the time of writing UK equities have declined 5% since the market’s December year end close, and 10-year gilt yields have hit multi-century lows around 1.13%.

Rightly or wrongly these indicators price the likelihood of an economic slowdown or outright recession following Brexit and, in either scenario, the lower discount rate on pension liabilities implied by bond yields will push those costs higher, potentially building a greater long-term burden for local government.

More immediately Brexit would almost certainly result in interest rates being anchored where they are for longer still.  Banks already facing margin pressures may be forced to withdraw or reduce depositor rates even further with an immediate impact on revenues from treasury cash.

If Brexit were followed by material curbs on immigration, both from Europe and the wider world, there must surely be questions as to how local government will both resource and fund care homes and other sectors dependent on the lower paid people in human resource-heavy parts of local government economies.

Who will replace the army of committed workers on lower wages working long and unsocial hours?  Will those wages need to inflate to attract local labour in the absence of other lower cost sources?  The withdrawal of one of the structural disinflationary forces of the last twenty years could have a meaningful inflationary outcome.

Longer term, if Brexit were to resemble the UK’s escape from EMU (European Monetary Union) as some certainly hope, and if that exit were in fact the release mechanism to allow more robust growth in the economy, the outcome could be positive for local government; higher than budgeted GDP growth would swell local and central revenues, rising interest rates could replenish treasurers coffers and shrinking pension liabilities would reduce their long-term cash burden. But for this to be a “real” gain it would need to occur in a low inflation environment.

Stephen Fitzgerald

Stephen Fitzgerald
Management and financial consultant

In the public sector most of us have confronted the EU procurement rules, which can, on occasion represent one of the most frustrating pieces of bureaucratic process that a public servant can come across.  Then, of course, we have Transfer of Undertakings – Protection of Employment (TUPE) rules which add a layer of complexity to any public-private partnership.

But the funding of public services is dependant on the ability of the United Kingdom to build and sustain economic growth.

This is the case across the whole sector and particularly true in local government where, in the future, funding levels will be driven by the ability of local authorities to generate business rates.  The health and sustainability of public services is rather dependant on which position is most likely to generate economic growth.

Much of the weight of business and economic opinion expresses concern for the economy in the case of an

David Cameron in Brussels

exit, which cannot be countered by extra income stemming from reduced payments to the EU.

Additionally, our public services have benefited from the skills of staff recruited from across the EU. And while some may have reservations about the impact on British culture of migration, we must also remember that there are whole swathes of France, Spain and Portugal where you will only hear English spoken.

So, the freedom of movement does bring benefits to the UK and its citizens, whether at home or abroad. It would seem that a vote to leave would be inconsistent with the principles of diversity and equality of opportunity.

If public services are to be a priority in the UK going forward we need a future that will provide the business environment for the sector to flourish so enriching society as a whole.

James Bevan

James Bevan
Chief investment officer at CCLA

The yield on Germany’s benchmark ten-year bonds recently hit zero and briefly entered negative territory, with the strong demand for sovereign debt (which pushes down yields) standing out in cautious trade ahead of a series of policy meetings at major central banks, and amid rising concern at the prospect that the UK could vote to leave the EU in the 23rd June Brexit referendum.

UK government debt yields also touched new lows with the yield on 10-year gilts down almost three basis points to 1.183%. Yet the ONS confirmed underlying inflation – which strips out changes in the price of energy, food, alcohol and tobacco – has held steady at 1.2%.

The only way that the investor can make more than 1.183% from the ten-year gilt is if prices rise further,

Photo: © European Parliament – Audiovisual Unit

pushing yields lower, and they pass the parcel before the music stops.

Betting against the central banks looks risky – but following their lead directly condemns investors to woefully low yields and by extension long-term returns.

Local authorities keen for more yield may reasonably question what is risky, recognising that global consumers continue to scrub their teeth, buy toothpaste and provide cash flow to investors.

The current ultra-low bond yield environment implies that it may well be reasonable to pay far higher prices for genuine cash flow and growth than the market is presently prepared to accept.

Rob Ford

Rob Ford
Founding partner and portfolio manager at TwentyFour Asset Management

We have always believed that the biggest fear around the EU referendum is the uncertainty it brings.

If the potential result looks like it will be close, as the day of the vote approaches, then the likelihood of price volatility in the market will increase.

A vote to leave would almost certainly extend that uncertainty and therefore volatility for a significant time as the two-year work-out period begins.

Almost certainly there would be a sharp “risk off” reaction from markets.  Stocks would be down, possibly a lot in the FTSE, GBP will be hit, especially against the US dollar, and only “risk-free” assets (gold, US Treasuries etc) will rally.  Gilts may rally eventually but may also be caught up in the initial turmoil.

We could then see a rate cut in July.  Prices in all UK fixed income credit assets will fall, but possibly also

Last year’s debate on CAP in Brussels

not just in the UK.  Finally there is a real fear that it could be the catalyst for a break up of the EU.

Those scenarios are going to be tough for any investor to deal with.  Local Authorities whose cash is generally invested in shorter dated assets will suffer less, but other investments may well get badly hit.  It will be a rocky ride.

It’s tough to hedge other than be long cash, where investment returns don’t justify more complex hedges such as currency options.

Mark Horsfield
Director, Arlingclose