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Wake up to Brexit risks, UBS to Morgan Stanley tell investors

Investors are being urged to tune into the looming political battle over the UK's membership of the European Union amid signs it will prove closer than most now think.

[LONDON] Investors are being urged to tune into the looming political battle over the UK's membership of the European Union amid signs it will prove closer than most now think.

UBS Group AG, Citigroup Inc and Morgan Stanley are among the banks advising clients to pay more attention to the so- called Brexit debate. They are doing so as opinion polls show diminishing support for staying in the 28-nation trade bloc even before Prime Minister David Cameron sets a date for the referendum he has promised by the end of 2017.

Citigroup last month raised its probability that voters will choose to withdraw from the EU to as high as 30 per cent; Nomura boosted its estimate to 25 per cent and Societe Generale SA this week stuck by its 45 per cent call. Morgan Stanley said last week that the chance of leaving is not "adequately priced" into UK markets.

"People should have it on their radar right now," said David Tinsley, an economist at UBS in London. "Regardless of your view of Europe, you'd expect some volatility if the possibility of departure increases." Long-standing hostilities toward the EU within Cameron's ruling Conservative Party will be on display this week as it holds its annual conference in Manchester. Europe's migrant crisis is threatening to fan anti-EU sentiment and there are fresh questions over the opposition Labour Party's traditional pro-EU stance since Jeremy Corbyn became its leader.

"There will come a point between now and the referendum date when markets will start to focus much more closely on Brexit risks," Michael Saunders, chief European economist at Citigroup, wrote in a report last month. "A vote for Brexit would threaten the UK's economic and political stability." Uncertainty over the vote outcome may prompt gilt traders to discount any prospect of higher interest rates from the Bank of England in the advance of the ballot, according to UBS. Bets on a 2016 rate increase receded further on Monday after a weaker-than-forecast report on services highlighted the fallout from cooling growth in China and emerging markets, Sonia forward contracts show.

As the EU debate heats up, the stocks of financial and commercial real estate companies may suffer given they could lose out the most if voters choose to quit the EU, the Swiss bank said in a report last month. At Societe Generale, strategist Kit Juckes lists Brexit among the "big, fat, ugly" outside risks leading him to bet on a weaker pound.

"We're seeing more and more clients concerned about this," said Ian Harnett, chief investment officer at Absolute Strategy Research Ltd. "It's going to be an issue coming through and one that will introduce a degree of uncertainty in UK markets." Quitting the EU would jeopardise the UK's tariff-free access to 500 million customers - the EU bought almost half of British exports of goods and services last year - as well as its ability to draw foreign investment and shape continent-wide regulations. Those who want to cut ties say new trade deals could be struck and that the EU swamps businesses with red tape, drains taxpayer money and leaves the UK vulnerable to an influx of foreign workers.

The divisions are increasingly reflected in narrowing polls, which may roil markets as they did ahead of 2014's Scottish referendum. A YouGov survey released last week found 40 per cent wanted to leave the EU and 38 per cent wanted to stay put,  giving the Brexit camp an advantage for the first time in almost a year.

Doubt also surrounds just what Mr Cameron can secure in his efforts to renegotiate the terms of membership and also when the referendum will be held.

While Mr Cameron has pledged to "get the things Britain needs" in his negotiations with other EU leaders, businesses are calling for the vote to be held sooner rather than later to avoid damage to investment. Warning of a 50-50 possibility of Britain opting to leave the EU, the Institute of Directors will say on Tuesday that a referendum in 2017 risks becoming "a chance to whack the political elite" after almost seven years of Tory rule, instead of a vote on the issues.

The UK's place in Europe is already reopening old wounds within the Conservatives. Tory lawmakers last month defeated Mr Cameron's attempt to allow civil servants to work in support of his position in the run-up to the referendum. Former Chancellor of the Exchequer Nigel Lawson said last week he'll lead a campaign for Britain to leave the EU, arguing that the government won't succeed in securing the necessary reforms.

A report published Friday by the Open Europe think tank, which examined recent public statements by the Conservative Party's 330 lawmakers, found that 69 would probably back an exit from the EU, with 203 likely up for grabs. Only 58 seem assured to vote for Britain to remain in the bloc.

While Labour's conference backed staying in the EU, Corbyn was more skeptical of it prior to his surprise election as Labour leader last month. That makes Philip Rush, an economist at Nomura in London, say Labour's support for the EU may still weaken.

"Whatever one believes the pros and cons about leaving, we should expect the associated uncertainty to have an impact on investment decisions and capital flows ahead of the event," said David Owen, chief European financial economist at Jefferies International Ltd.