'Brexit' Voter Turnout Impact Weighed After Dutch Referendum

Photographer: Chris Ratcliffe/Bloomberg

Opinion polls show as many as one in three U.K. voters are undecided about whether they will vote and if they would back leaving or staying in the European Union at the June referendum, spurring debate about what a low turnout would mean for the result and for the pound.

Developments that could impact sterling in coming months are surveys on voting intentions, the selection of the official “in” and “out” campaign groups, the refugee crisis and political developments in the EU.

The spread between implied and realized volatility in the pound versus the dollar on the three-month tenor rose to a record on Thursday, as voters in the Netherlands used a referendum on a treaty between the European Union and Ukraine to rebuke Dutch and EU leaders.

What's the latest?

The Dutch news prompted U.K. Prime Minister David Cameron to say he hopes the result won’t affect the British referendum, in a speech targeted at encouraging younger people to vote. Last month, he said the U.K. result is on a knife edge and could be decided on who bothers to vote.

Lynton Crosby, a political strategist who organized the government’s election campaign in 2015, says those in the “leave” camp are still more likely to cast a vote on polling day.

Most recent polls show the two camps are virtually neck and neck. End-March telephone polls, deemed to be more accurate, showed the remain camp’s lead had narrowed.

The turnout at the Dutch referendum was just 32 percent. If the turnout were anywhere near that low in the U.K. vote, it would raise the possibility of a U.K. exit, according to Nomura analyst Philip Rush.

Meanwhile, JPMorgan analyst Allan Monks says this risk may be overdone as interest in the "Brexit" debate looks high relative to past referendums and elections. Uncertainty over jobs and economic stability, versus attitudes toward migration and security are the factors that will impact the result, Monks adds.

Source: JPMorgan

Cameron’s 9.3 million pound plan to send a leaflet “to set out the facts” on the referendum to every U.K. household was attacked as “propaganda" by Justice Secretary Michael Gove, one of the leading campaigners for a U.K. exit.

The Bank of England said last month uncertainty over the U.K. referendum may hold back investment and growth, though MPC member Kristin Forbes said there’s not yet enough data to estimate the impact.

The U.K. current-account deficit surged to 7 percent of GDP in the fourth quarter of 2015, before the referendum date was known, and adds to concern a vote to leave could see a sharp slowdown in investor inflows. Standard Chartered analyst Eimar Daly says uncertainty is leading to reduced foreign inflows, with M&A deal announcement values down sharply since December 2015.

What's next?

The Electoral Commission’s deadline to determine the official ‘‘leave” and “remain” campaigns is April 14, and the referendum period starts the day after. The decision gives the lead campaign groups higher spending limits.

JPMorgan says a successful implementation of the deal between the EU and Turkey to stem migration flow would lower the likelihood of “Brexit.”

UBS Wealth Management analyst Ricardo Garcia says if the deal leads to lower migrant inflows, that will be more important in voters’ minds than last month’s terror attacks in Brussels. Once the campaign starts formally and Cameron campaigns more pro-actively, it will be important to see if the undecideds make up their minds and which campaign they back. Most will probably favor staying in the EU, Garcia adds.

What's the likely referendum outcome?

Polls show the “remain” and “leave” campaigns are fairly balanced, and the number of undecideds range from 16 percent to 28 percent in surveys since end-February.

RBC says betting markets are a better gauge of implied probabilities. For now, they show around 69 percent support for the "stay" campaign, according to betting odds website oddschecker.com.

UBS Wealth Management sees around a 30 percent chance of "Brexit," while Citigroup puts the likelihood at 30 to 40 percent. Meanwhile, IHS sees 35 to 40 percent probability of a vote to leave.

What happens if the remain camp wins?

The vote may spur persistent political and economic uncertainties that may not end even if the U.K. votes to stay, Citigroup analysts say.

Even if the U.K. votes to remain in the EU, divisions resulting from the referendum could lead to early elections, according to Morgan Stanley analysts. The bank’s economists say even if the “remain” camp wins, slower growth and weaker inflation would push the first BOE rate increase back to early 2017, while ING analysts say if the U.K. votes against “Brexit,” the BOE could lift rates as soon as November.

BNY Mellon analysts note pound strength after the Scottish referendum faded just hours after the result, while Morgan Stanley says sterling could recover slightly but won’t retrace all of its losses since mid-2015. Julius Baer analysts see asymmetrical downside risks for sterling, believing a long-lasting relief rally is unlikely in case of a vote to stay.

What happens on Brexit?

EU provisions suggest negotiations can take up to two years but some commentators say that period could be extended, if needed.

In the worst case, the economy would be 3.9 percent smaller by 2030 compared with staying in the bloc and 21.1 billion pounds of business investment would be lost, Oxford Economics says, adding that the best case scenario would see a loss of 0.1 percent in GDP.

Analyst estimates for pound declines from Barclays to HSBC range from 10 to 20 percent. Citigroup rates strategists say the sharp fall in sterling and the likelihood of a rapid uplift in inflation could stay the central bank’s hand.

British manufacturers, retailers and universities may see their credit ratings slide if the U.K. votes to leave, according to credit rating company Moody’s.

Fund managers Aberdeen and Henderson face the largest operational risks in a “Brexit” scenario, according to UBS equity analysts. The U.K. retail sector may de-rate, the bank says. Meanwhile, a vote for an exit will spawn the deepest European high-yield market slump since the Greek debt crisis, analysts and investors say.

Any market turmoil after a vote to leave could also stop Federal Reserve rate increases, UBS Wealth Management global Chief Investment Officer Mark Haefele says in an interview.

How to trade it?

Investors should brace for a more than 4 percent drop in the sterling in the referendum run-up, according to Validus, the currency’s most-accurate forecaster in the first quarter of 2016.

Nomura stays short sterling versus the dollar with a 1.40 digital put expiring just before the referendum. The analysts aren’t looking to add to exposure unless there’s a squeeze higher to 1.44-1.45.

An escalation of the Greece situation, alongside the U.K. referendum, could drive peripheral spreads wider, weigh on the euro and increase the currency’s volatility in the summer, Barclays analysts write.

HSBC says being long the Swiss franc is the best hedge against the risk of "Brexit."

In the rates space, TD Securities and ING favor Dec 16/Dec 17 short-sterling steepeners, with TD saying market pricing of a BOE rate increase is too extreme.

Citigroup analyst Jamie Searle agrees the U.K. front end is too rich and that will likely reverse, whatever the result in June. He says paying the front-end outright or cross market is a good hedge, though it’s still too early.

If the U.K. were to vote to leave, gilts wouldn’t be on the top of investors’ list of British assets to sell, Newton’s Howard Cunningham says in interview. He slightly prefers linkers, saying they could find support whatever the outcome. Aviva Investors agrees, saying the outlook for gilts isn’t clear as U.K. government debt could benefit from domestic haven flows, even as they suffer from international outflows.

“Brexit” risks and increased ECB purchases support long-end euro rates, Societe Generale rates analysts say. They recommend buying EUR 10s30s conditional bull-flatteners with one-month expiry. Barclays equity analysts recommend U.K. stocks with dollar exposure, FTSE 100 companies and consumer staples.

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