What will happen to the financial markets if there is Brexit?

An intense burst of volatility in financial markets on Thursday night and Friday morning is more or less assured

Brexit could even have a negative impact on the mighty American economy (Getty Images)

So will there be market mayhem?

In the immediate term, an intense burst of volatility in financial markets on Thursday night and Friday morning is more or less assured, regardless of the outcome of the referendum vote. The outcome of the plebiscite is the dominant issue in the minds of traders and asset managers in the City of London and, increasingly, in other financial centres across the world. Various indexes of expected market volatility have been rising in recent weeks.

Who will be trading?

Some financial players, such as hedge funds, will be speculating on the outcome (or, more precisely, market movements in response to the outcome) with their own money. Other players, traders working for banks, will be anticipating a rush of orders from corporate customers for various assets in response to the outcome and they will be looking to position themselves to make a profit by making a market for these clients. There is expected to a be a frenzy of action in the spread-betting markets too on the value of currencies, as there usually is for high-profile political events with economic implications (such as general elections).

Is this just a UK phenomenon?

No. Movements in financial markets in recent weeks suggest that many now see the economic fallout from Brexit as of material importance not only for the UK economy, but for other states around the world too. Janet Yellen, the chair of the US Federal Reserve, today said Brexit could even have a negative impact on the mighty American economy. Stocks moved up throughout the world on Monday, a shift that was attributed by traders to perceptions of the risk of Brexit receding.

Which markets will be affected?

There is expected to be sharp movements in currency markets – particularly the pound versus the US dollar and the pound versus the euro. There is some expectation of major currency moves even before the polls close at 10pm because hedge funds and banks are rumoured to have commissioned private exit polls upon which they may trade. There will certainly be action throughout the night after polls close because traders will be responding as the results are announced by various districts throughout the country and the overall result comes into focus. There will be movement in “futures” markets for stocks and shares of UK-based companies overnight too. This will give some indication of the market reaction for equities. But heavy action for shares and bonds is expected from 8am on Friday when trading in the London Stock Exchange kicks off.

Which way will markets move?

Sterling strengthened considerably on Monday as traders discerned a strengthening of the Remain position in the poll. And many traders expect a Remain vote to push up the value of sterling further. Many expect a Leave to suppress the value of pound against other currencies, reflecting a bleaker output for the UK economy outside the single market. Some have estimated a fall in the value of sterling against the dollar of as much as 20 per cent. George Soros, the hedge fund boss who made a £1bn personal profit from betting against the pound on Black Wednesday 1992, when it fell 15 per cent, said this week that he expects an even bigger fall this time if Britain votes for Brexit. As far as stocks and shares are concerned, large international banks with exposure to Europe such as Barclays, Royal Bank of Scotland and HSBC could well be marked down in the event of a Brexit vote. Exporters to Europe could suffer too in anticipation of the return of tariffs. Tourism firms with big revenues from Europe such as the airline Easyjet and the cruise operator Carnvial could come under pressure. UK property and house building firms would also likely suffer if the domestic housing market comes under pressure. A converse boost to such shares is likely in the event of Remain. The outlook for UK Government bonds (Gilts) if Leave wins is more ambiguous. In a general market flight to safety Gilt prices have tended to rise in recent years since they are seen as safe assets, like Gold or US Treasury bonds. This would probably happen again. But Brexit could theoretically make them less attractive to investors if the view was that the UK had suddenly become a less desirable place to park money, sending their price down.

What will happen to interest rates?

The long-run interest rate is set by the yield on government debt, so that would depend on the attractiveness of Gilts after a Brexit vote. But the short-term rate is set by the Bank of England. Some economists say the Bank would be likely to cut rates further from their historic lows of 0.5 per cent in the event of a Brexit vote to support the economy and reassure investors, possibly also restarting the bond-buying QE programme. Others argue that if there is a major run on the pound, stoking expectations of a dangerous spike in domestic inflation, Threadneedle Street would need to raise rates to restore investor confidence, even though this would harm the economy and, in all likelihood, help tip Britain back into recession.