The latest polls indicate that the outcome of the referendum to be held in the UK on 23 June on its membership of the European Union (EU) will come down to the wire. 
Many continue to view the EU referendum as a purely UK-centric event. It is not. The EU is likely to ‘punish’ the UK for exiting the EU so as not to provide an easy precedent for other EU members to take the EU exit path. The rise of Eurosceptic political parties in the major Eurozone countries should be monitored.
One of the most volatile market events ever
The vote will be a pivotal point in the UK’s political and economic landscape. A vote to exit the EU (Brexit) is likely to trigger declines in global equity and commodity markets of a magnitude that would lead to a reassessment of global growth. That’s why Brexit is potentially one of the most volatile events in history for financial markets.
Volatility in the GBP/USD exchange rate is as high as the 2008-09 global crisis. For the AUD/GBP exchange rate it is as high as the 2010-2012 Eurozone crisis. Volatility will further spike on 23-24 June, with markets on edge once voting stations close at 7am AEST 24 June.
The negative impact on GBP and broader asset markets if the UK votes to exit the EU should far exceed the ‘relief rally’ that would follow a UK vote to remain in the EU. This partly reflects the uncertainty – markets don’t like uncertainty – from the unknown impacts on pockets of the global financial system and global economy, from a tightening in financial conditions.
Risk is under-priced
If the UK votes to leave the EU, we expect sharper moves in exchange rates than are currently priced:
- GBP/USD – options market is pricing in a 7.5% decline. We expect an initial fall of 10%
- AUD/GBP – we expect the AUD to strengthen by up to 8.3%
- AUD/USD – options market is pricing in a 1.0% decline. We expect a decline of 2.5%, possibly even more initially.
Our forecast for a bigger reaction in AUD/USD reflects:
- Our expectation that falls in global equity and commodity markets will lead to a reassessment of the global economic growth outlook
- AUD/USD has a long history of big reactions to negative global events
- The referendum results will be released in the less-liquid Asian time zone. We estimate that over the past 12 months just under 10% of GBP/USD foreign exchange transactions have occurred between 7am and 4pm AEST, the time zone when the referendum results are expected.
Potentially there may be no price at times if market participants judge it too risky to transact given erratic price action. If a liquidity vacuum eventuates, the major central banks will likely intervene to provide liquidity.
When will we know the results?
The first of the 382 local counting areas will release results around 9am AEST while the bulk of regions look set to release results between 12.30pm and 2pm AEST. Official results are likely by 6pm AEST.