Highlights

• Given the disappointing US May jobs data and still uncertain global growth, the risk of Fed June hike dissipated and market is turning attention to Brexit risk.

• As a single entity, the EU is the second largest economy in the world. EU GDP was worth US$16.2tn in 2015, just a tad smaller than US (US$17.9tn). The UK economy accounts for 18% of EU GDP. A decision to leave EU (Brexit) would result in uncertainties in trade and financial policies until alternative agreements are made. A Brexit would also affect the sustainability of EU project in the long-term.

• The EU is a significant trading partner of the UK, accounting for 50% of total trade. Within the EU, Germany, Netherlands and France (26%, 14%, 12% respectively) constitute half of EU total trade. A Brexit may require the assent of the remaining 27 members to negotiate a new trade agreement. UK trade agreement with the rest of the world could also be jeopardized (previously riding on EU trade agreements). Exports account for 28% of UK GDP.

• A Brexit would not lead to immediate exit, as it could take up to two years for the EU to finalise a withdrawal agreement, in line with Article 50 of the Lisbon Treaty. UK-based companies would still need to abide by existing EU regulation until new agreement is agreed upon.

• FDI from the EU to the UK stands at 48% in 2014. In the event of Brexit, prolonged uncertainty and reduced benefits for foreign-owned businesses might lead to relocation from UK especially those who prioritise unrestricted EU access. In this regard, some major foreign investors (GE, Airbus, Cisco, Mars) have highlighted the risk of future investment pullbacks should Brexit prevail.

• The position of UK as an international financial centre could be affected after Brexit as it would be harder for London to effectively serve the European markets. UK financial sector accounts for 24% of EU financial services activity.

• Closer to home, impact to the Malaysian economy through trade and investment is rather limited. Malaysia’s trade with UK is small, amounting to 1% of total exports while FDI from UK is 4% (2008-2015 average). Risk to Malaysia emanates mainly from a possible growth slowdown / recession in UK and EU post Brexit as well as contagion of financial volatility.

• In the US, the dismay job creation in May (+38,000) pointed to fragile and uneven labour market recovery amid lower unemployment rate (4.7%). On a positive note, average hourly earnings growth remained solid at 2.5% yoy. With the mixed job data in May coupled with the looming Brexit risk, we now expect the FOMC to delay its 2nd rate hike to July (26-27 July, even though it’s non-live). We still maintain our total rate hike expectations at 50bps (Jul & Dec respectively).

• Our baseline scenario is for the UK to remain, i.e. Bremain, hence business as usual under current economic setup. Consequently, our projection of Malaysia GDP growth for 2016 is also maintained at 4.2% with an unchanged OPR throughout the year.

Source: Hong Leong Investment Bank Research - 7 Jun 2016