Key markets that support corporate investment could be destabilised in the wake of a Vote Leave success in the EU referendum, the Bank of England’s (BoE’s) Financial Policy Committee (FPC) has warned.
In a statement from its most recent policy meeting, the FPC said that “heightened uncertainty” around the UK’s territorial status, which has already begun to emerge, will become particularly testing around the time of the poll. In the event of a pro-Brexit result, the Committee cautioned that uncertainty could place a strain on core funding avenues that have already shown signs of fragility.
So far, the FPC noted, the effects of uncertainty have been most noticeable in sterling spot and options markets. “Looking ahead,” it said, “heightened and prolonged uncertainty has the potential to increase the risk premia [that] investors require on a wider range of UK assets, which could lead to a further depreciation of sterling and affect the cost and availability of financing for a broad range of UK borrowers.”
Those pressures, the Committee explained, “have the potential to reinforce existing vulnerabilities for financial stability. The UK current-account deficit remains high by historical and international standards. The financing of that deficit is reliant on continuing material inflows of portfolio and foreign direct investment. Those flows have contributed to the financing of the public-sector financial deficit and corporate investment – including in commercial real estate.
It added: “Heightened uncertainty could test the capacity of core funding markets at a time when the liquidity of these markets has shown signs of fragility across advanced economies. In addition, the impact of a decision of the UK to withdraw from the EU could spill over to the euro area, driving up risk premia and further diminishing the prospects for growth there.”
The FPC said it was broadly confident in the resilience of UK banks, largely on the basis of a 2014 stress test that incorporated a sharp depreciation of sterling, a spike in unemployment and a lengthy recession. The results of that test suggested that banks and building societies could withstand a “severe shock” akin to what a Vote Leave may trigger, enabling them to continue serving households and firms.
The Committee also welcomed a recent announcement from BoE management that the bank would offer three additional indexed long-term repo operations in the weeks around the referendum, while continuing to offer dollar liquidity – providing banks, building societies and broker dealers with the means to obtain liquidity against the full range of eligible collateral in the Sterling Monetary Framework.
In its general thrust, the FPC’s statement echoed a recent opinion from ratings agency Fitch, which warned that Brexit would compound a tough outlook for UK-based, leveraged retailers – businesses that were especially likely to “come under pressure from macroeconomic uncertainties, particularly if exit negotiations were protracted and acrimonious”.
Fitch zeroed in on homeware chain BHS’s 23 March agreement with creditors and landlords to cut rent payments on many of its high-street premises as evidence of the liquidity hurdles that are facing brand chiefs who are “trying to balance multi-channel distribution investment and logistics against shrinking margins and working-capital swings due to stock clearances and product-mix revamps”.
The agency also noted that Next Plc’s recent forecast of a difficult 2016 “shows that even retailers that have successfully adapted their business models are finding it hard to maintain sales growth and profitability”.
Just days before that Fitch opinion, fellow ratings specialists Moody’s published a notice suggesting that Brexit would impact upon bond issuers – with any new barriers to trade raised by the UK’s departure likely to blight the creditworthiness of non-financial companies.
In particular, Moody’s said, “Infrastructure companies could face uncertainty around new regulatory regimes.”