Britain heading into a sterling crisis if it crashes out of the EU

2016 is a year of reckoning for Britain as the nation heads into a crucial referendum on whether the country leaves the European Union. It is a critical vote that could seal the UK’s political and economic fate for decades to come.

British exit from Europe – known euphemistically as Brexit – would have dire consequences for the country. If the UK crashes out, vital economic links with Europe, Britain’s biggest trading partner will suffer major disruption. Droves of major companies could desert the UK for good.

In the worst case scenario, it could lead to a messy break-up of the British union. All the hard work rebuilding Britain’s recovery after the 2009 global financial crisis could be destroyed at a stroke. The UK could end up on the road to economic ruin with full-blown depression following in Brexit’s wake.

It could have dreadful consequences for UK financial markets. Some international credit rating agencies have already hinted at the risk of a significant downgrade for Britain if it leaves the EU. It would lead to a crash in UK stocks and government bonds, sparking another serious run on the pound.

The die has been cast for trouble ahead, ever since Prime Minister David Cameron made an election pledge to hold a vote on EU membership by the end of 2017 to assuage euro sceptics in his Conservative party. But the risks are rising that the poll will be held as early as 2016.

It will be a very close shave judging by recent survey results. Voter opposition to the EU has never been so high, with public opinion split down the middle on staying in or leaving. There is a growing perception that there would little systemic risk to the economy should Britain leave.

Without a doubt, the structural risks of Brexit are extremely high. The threat to national output and jobs are severe. But it also works two ways. Britain is such a large part of the EU economy, there would be negative fall-out for Europe as well.

Putting hard numbers on the potential loss to British output and jobs is an extremely contentious issue. It is often argued that as many as 3 to 4 million British jobs would be at risk if the UK leaves. In the worst case scenario, if the UK failed to negotiate a viable free trade deal with Brussels, Brexit’s impact on the economy would be calamitous.

Around 50 per cent of UK trade is with the EU, so any barrier to the free flow of British goods into the single market would hit British industry hard. There is a bigger risk that multinational companies, with European headquarters based in Britain, would be under a strong imperative to up roots and move into Europe to guarantee continuing access to the free market area.

Many foreign companies, especially Asian car manufacturers lured into Britain over the past to enjoy special regulatory and tax advantages, could jump ship to relocate operations into the EU’s cheaper manufacturing locations, especially in Eastern Europe. It would take years to replenish the loss of inward investment capital.

It would be a potential death knell for British industry, which has been struggling against a one-way tide of de-industrialisation over many decades. Ten per cent of UK national output could easily be wiped out in subsequent years following Brexit.

Britain’s pole position as Europe’s foremost financial hub would be under serious threat too. The EU would hardly stand idly by and let London’s financial markets operate in free and easy isolation. EU tax and regulatory requirements could provoke a huge exodus of major banks and financial institutions from the UK, with the loss of hundreds of thousands more British jobs.

There is also the risk that Scotland would use Brexit to call for another vote on independence from the UK to protect its own EU status. If Scotland breaks from Britain, it easily could slice a further 10 per cent off UK GDP.

The UK economy will be in extreme risk in the next few years, which will not be lost on the markets. The UK pound will be very vulnerable and could put sterling back into the grip of a major confidence crisis. A test of parity against the strengthening US dollar should not be ruled out in the future.

Brexit could be the final political act that takes the great out of Britain and casts the nation into the economic wilderness for years.