Brexit: More Pain for EU Than Britain?

For starters, seeing Britain exit might, over time, give other European countries ideas that their membership in the EU or the euro isn't permanent either.Who should be more worried about Brexit – Britain or the European Union? It’s Britain, if the answer is based on activity in currency options markets. In an unusual move, implied volatility on 90 Day at the money (ATM) GBPUSD options recently jumped significantly above that for EURUSD. There have only been a few occasions over the past five years when the implied volatility on pound options equaled, much less exceeded, the implied volatility on the euro (Figure 1).

The unfolding of the Brexit story has understandably focused a great deal of attention on the United Kingdom and the likely risks if the “leave” vote carries the day in the June 23rd referendum to decide if the U.K. remains in the European Union (EU).  That said, we are not convinced that enough attention has been paid to the risks to the euro and the EU.

From the perspective of the United Kingdom, the risks of a Brexit might be exaggerated:

  • The U.K. never joined the euro common currency or the Schengen common visa area.
  • Norway and Switzerland, which are not EU members, have prosperous economies whose commercial, industrial and financial sectors are deeply integrated with the rest of Europe.
  • If the U.K. leaves the EU, negotiations will take place to likely put into place treaties that maintain much of the U.K.’s current relationship with the EU.

This isn’t to say that a Brexit would be risk free for Britain.  It would lose its place at the table in Brussels, and many details of its departure would have to be negotiated, including trade deals as well as the fate of millions of citizens of other EU states currently residing in Britain.  Additionally, a U.K. exit might encourage another push for Scottish independence, which could compound GBP volatility.

Figure 1: GBP Implied Options Volatility is Usually Lower Than That of EUR Options.

That said, the risks of a Brexit might be far larger for the EU and, in particular, for the euro zone.  For starters, seeing Britain exit might, over time, give other European countries ideas that their membership in the EU or the euro isn’t permanent either.  The most obvious candidate for exit is Greece, whose economy is contracting again under the weight of another disastrous austerity program.  Greek Prime Minister Alexis Tsipras recently accused the International Monetary Fund (IMF) of trying to push the country into default, an allegation that the IMF denies.  What is clear is that the Greek crisis is far from over and if it heats up again could create additional volatility for the euro but would probably have little impact on the pound whether the U.K. stays or leaves. 

If the U.K. does vote to leave, it might give other countries similar ideas over the long term.  Politically far right and Eurosceptic parties are quickly gaining support in Germany while long established parties of a similar stripe continue to grow in Austria, Denmark, France, the Netherlands and Sweden.  Spain’s political system is also fragmenting.  None of this will make it easier for Europe to deal with other problems that erode support for the common visa area such as immigration issues, and the massive debt that has tied Europe to slow economic growth and negative short-term interest rates.

In the event of a “stay” vote, implied volatility on GBPUSD options will probably decline substantially more than that on EURUSD options.  If U.K. votes to leave, there might be a short-term spike in GBPUSD implied volatility relative to EURUSD, but the long-term view is less certain.  A victory for those who want to “leave” might ultimately create as much or more volatility in the euro than it does in the pound. 


All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only.  The views in this report reflect solely those of the authors and not necessarily those of CME Group or its affiliated institutions.  This report and the information herein should not be considered investment advice or the results of actual market experience.

About the Author

Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.

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