1 THING THE EUROPEAN INVESTMENT-GRADE FIXED INCOME TEAM TALKED ABOUT LAST WEEK

Tanguy is Head of Fixed income Europe, Pioneer Investments

It wasn’t the only thing that the European Investment Grade Fixed Income team talked about last week, but the forthcoming UK EU membership referendum did dominate our discussions. We discussed the U.S. Federal Reserve sending another dovish message on U.S. rates, despite their attempts in the weeks running up to the meeting to talk up expectations. We also talked about the Bank of Japan’s decision to leave policy unchanged at their meeting last week, causing the Nikkei 225 stock market to fall and the Japanese Yen to appreciate further. We noted that the German Constitutional Court will publish its verdict on the European Central Bank’s (ECB) Outright Monetary Transactions (OMT), which has the potential to limit the ECB’s Quantitative Easing programme. We chatted about the Spanish national elections on June 26th 2016, which in our opinion, is unlikely to yield a clear winner. But we kept coming back to the “BREXIT” debate, mainly because, for the first time in the campaign, the polls began to consistently show a small lead for the “LEAVE” campaign. This led to a “risk-off” mentality in markets in the middle of last week, which subsided a bit towards the end of the week.

Tanguy Le Saout
Tanguy Le Saout

With the polls so close, it is probably futile to try to call the winner. But what we can do is to discuss some of the logistical issues surrounding the actual referendum and the aftermath, regardless of the outcome.

Technically the 2015 EU Referendum Act is not legally binding. It is, like many other referendums, devoid of consequential legal effect, and so the result is advisory rather than mandatory. Theoretically, the government could, in strict law, choose to ignore it, but in practice the outcome should be binding on the government.

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Polling closes at 10pm on Thursday June 23rd. Counting starts immediately. There will be no official exit polls, since exit polls are based on the “swing vote” and there is no recent voting statistics to compare with. Results will start coming in from the counting centres from 1am onwards. By 4am we should have about 50% of the area results announced, with over 80% by 5am. The final tally is not expected until “breakfast time” when it will be announced by the Chief Counting Officer at Manchester Town Hall, but the result may be clear well before then, depending on the closeness of the vote.

In the event of a “LEAVE” vote, the two big unknowns are the UK Prime Minister David Cameron’s future and the timing of the triggering of Article 50 of the Lisbon Treaty. The two are linked in that both can happen independently but in practice, they are likely to be linked. Speculation is that Cameron may resign if the “LEAVE” vote is successful, and even if he doesn’t resign, he would be likely to face a leadership challenge from a Conservative party that is deeply divided and fractured. The process for triggering a leadership contest is quite straightforward – it only takes 15% of Conservative MP’s (50 given their current number of seats) to call a vote of no confidence in Cameron. But it could take up to two months to elect a new leader.

Article 50 of the Lisbon Treaty is the mechanism by which the UK starts negotiations to extricate itself from the European Union. The Article sets a timeline of two years for the process unless both the EU and the UK unanimously agree a different timeframe. Given the UK is a large trading partner for most of the EU, it might suggest the process should be relatively smooth, but France has already warned that it will seek to penalise the UK for its decision. Germany and France may want to prove that leaving the EU carries an economic cost. Whatever happens, the UK is unlikely to get a better deal outside the EU than it had before leaving or than existing members have within the union. So the timing of the invoking of Article 50 is quite important. David Cameron has said he would do this quickly but if he has resigned or is being challenged as leader, the process might take some time. Ultimately, the decision as to when to invoke Article 50 is for the government – it does not need to be ratified by parliament, and it is unlikely that the triggering of Article 50 could be postponed for long.

If the vote is to “REMAIN”, there will obviously be sighs of relief, not just from David Cameron but from the markets in general. The first thing will be to ratify the deal that Cameron negotiated back in February, before the referendum campaign started. But Cameron could still face a challenge to his leadership, and the Conservative party is likely to be divided and fractious. Whatever the outcome, Cameron has already stated that he will not serve a third term as Prime Minister, so it is likely that the Conservative party will have a new leader at the time of the next election in May 2020.

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