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I was reading this article, George Osborne says Brexit would drive up mortgage rates:

George Osborne has issued a stark warning that mortgage rates will rise if Britain leaves the European Union.

The chancellor said he thought it was likely interest rates, and therefore the cost of home loans, would rise if Britons vote to leave the EU in the referendum on 23 June. But Brexit campaigners accused Osborne of panicking and resorting to intimidating voters.

Asked if he thought the cost of mortgages would increase on a British exit from the 28-nation bloc, Osborne said: “The short answer is yes. I think that is likely, but I’m not in charge of interest rates.”

I was wondering what is the transmission mechanism for explaining why interest rates would have to go up if Brexit happens? Moreover, is there any historical example and precedent for this happening?

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    $\begingroup$ Note that this is a journalistic bias, the exact quote is: Asked if he thought the cost of mortgages would increase on a British exit from the 28-nation bloc, Osborne said: “The short answer is yes. I think that is likely, but I’m not in charge of interest rates.” Not quite what the title suggests. $\endgroup$ – bilbo_pingouin Apr 18 '16 at 5:57
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What would happen in the event of a "Leave" vote in the referendum? Well, the pound would quickly fall in value against its major trading partners - and some falls have already happened as the "Leave" vote appears to increase in probability. That makes imports more expensive, which is directly inflationary. Which pushes the Bank of England (the UK's Central Bank) to raise interest rates in response.

On top of that there are second-order effects which would pull in the other direction, but over a longer time period: there's the directly deflationary effect of the significant increase in unemployment. And the increased risk of further disintegration of the EU, with all the consequential risks to peace and prosperity that that would bring.

And as Alexis L. points out, the UK leaving the EU adds significant risk to the UK's currency; and that corresponds to a need for a higher return on the currency: that return is the interest rate. That's because if interest rates are too low, then people would keep selling the pound sterling, and it would keep dropping in value, pushing up inflation (requiring higher interest rates), and harming UK companies that rely on exports (creating political pressure to do something about the exchange rate - and that "something" is higher interest rates).

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  • $\begingroup$ on your last paragraph, i cant see exactly why just because there is a need, why interest rates would go up, why couldnt they just accept a currency with a lower rate of return $\endgroup$ – Permian Apr 17 '16 at 15:53
  • $\begingroup$ @Jurassic because if rates are too low, then people keep selling and the pound would keep dropping in value, pushing up inflation (requiring higher interest rates), and harming UK companies that rely on exports (creating political pressure to do something about the exchange rate - and that "something" is higher interest rates). $\endgroup$ – EnergyNumbers Apr 20 '16 at 7:20
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Just to come back on your two questions: (i) whenever the market is getting "tense", interest rates go up. Because people usually sell their bonds, and so interests rates go up as these two are negatively correlated (if you don't understand this point please tell me I can explain it to you quickly in the comment). It is called a "sell-off". (ii) We have some historical example of such a movement on market for example with the Bund sell-off in the summer 2015, but also in a broader perspective when the UK left the European monetary system...

Make also sure to check this little document, which the UK has talked a lot about: http://news.cbi.org.uk/news/leaving-eu-would-cause-a-serious-shock-to-uk-economy-new-pwc-analysis/leaving-the-eu-implications-for-the-uk-economy/

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  • $\begingroup$ why would you sell bonds when markets are tense, surely if markets are tense there is a chance of monetary easing? $\endgroup$ – Permian Apr 17 '16 at 15:55
  • $\begingroup$ Place yourself in the shoes of a trader: if everyone is tense and wants to hold "money" over other financial assets they will surely close their positions (meaning selling financial assets). So the question is whether you're going to be the first or not ! And all the way round this provokes the sell off.. $\endgroup$ – Alexis L. Apr 18 '16 at 0:38

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