Breaking down Brexit

Sanisha Packirisamy, economist, Momentum Investments

On 13 March 2019, the amendment calling for the Commons to reject a no-deal Brexit at any time and under any circumstances was won by a margin of only four votes. Following the two defeats, the House of Commons voted in favour of May’s plan to apply to the European Union (EU) for a delay in Brexit until 30 June 2019. Currently no consensus exists between the 27 remaining EU member states on how long to delay the UK’s exit date and what conditions would need to be applied for this to occur. A further vote will still be held to agree to an alternative model for Brexit.

The latest YouGov polls for 10-11 March 2019 indicated that 37% of the Brits surveyed preferred the UK’s leaving date to remain intact and that the country should leave without a deal, while 33% of the sample surveyed suggested a new EU referendum should be held. The remainder are undecided or believe the leaving date should be extended. With the upcoming European Parliamentary elections to be held between 23 and 26 May, it is likely that the UK would need to participate in elections to the new European Parliament. May has threatened a longer extension to Brexit (possibly up to two years) if the vote continues to be contested by opponents of the deal.

At this stage, the timeline and outcome for Brexit remain unclear. With the new extension in place, the prime minister may attempt to cobble together a new version of the Brexit deal to be voted on in Parliament (including options for a softer Brexit) before the EU summit. This would require a turnaround from a significant number of dissenters, given the large margin of loss on the vote held on 12 March 2019. This includes 75 Tory MPs and 10 Northern Irish unionist MPs who voted in opposition to the agreement on 12 March 2019. May has suggested that unless they support her deal, they may have to accept a much softer form of Brexit. A Norway-type deal, in which the UK continues to stay within the customs union and retains single market membership, may attract support, while the government is more opposed to holding a second referendum. Although May has lost a second vote, she is unlikely to stand down, as this may raise more uncertainty and political instability. Moreover, with the government unlikely to lose a vote of no confidence at this stage, the probability of an election also remains low, in our view.

There are three likely outcomes in our view (a general election or second referendum could be intertwined with these options):

1. With a third try, a withdrawal agreement is ratified by the European Parliament and the European Council, which allows for a transition period through to December 2020 (or a transition period that is negotiated for longer)
   • This would imply a softer Brexit outcome with closer trade ties.
   • The Bank of England suggests growth in this scenario would be 1.75% higher after five years relative to base case.
   • A reduction in uncertainty allows for a resumption in fixed investment growth (there are currently signs of pent up demand).
   • Consumer demand is revived.
   • Sterling would strengthen to around 1.40 – 1.45 on a two-year view.
   • Inflation risk drops and should head back below the target quicker.
   • The Bank of England can respond by hiking once this year and once in 2020.

2. A further extension of Article 50 (from 30 June 2019 to further out)
• Near-term uncertainty will remain elevated.
• Businesses would remain reluctant to invest and consumers would delay spending.
• Sterling could move weaker to around 1.25 against the US dollar.
• The Bank of England would be unable to hike due to poorer growth outcomes.
• But inflation risk would rise as the sterling continues to weaken against the US dollar.
• Stagflation risk (low growth and high inflation) would arise.

3. No deal Brexit
• The UK government estimates growth would be 7.5% lower after 15 years.
• Uncertainty would remain high.
• Businesses would remain reluctant to invest and consumers would delay spending.
• Sterling could move weaker to around 1.10 against the US dollar.
• Inflation risk would rise on additional sterling weakness.
• Higher stagflation risk would emerge.
• Nevertheless, the Bank of England may be forced to cut interest rates in this scenario to save falling growth.

In terms of Brexit, any non-deal outcome by end-June should increase the uncertainty in financial markets, with a potential short-term detrimental impact on risky assets (global equities, property), with more defensive asset classes (bonds and cash) benefitting near term. But this is likely to diminish in time as markets get Brexit fatigue. It hence makes sense to stick to the SAA views that are time-independent to maximise the probability of attaining client outcomes.