Snapshot - Managers' views

Brexit deal defeat triggers huge uncertainty: what next?

Possibility of no deal Brexit is as high as ever, risking a UK recession this year.

21/01/2019

Azad Zangana

Azad Zangana

Senior European Economist and Strategist

Remi Olu-Pitan

Remi Olu-Pitan

Fund Manager, Multi-asset

  • In event of no deal, Schroders forecasts 2019 UK recession
  • Market expectations that soft Brexit is now more likely seem premature

Azad Zangana, Senior European Economist & Strategist, says:

As had been widely expected, parliament has voted against the ratification of the UK’s Withdrawal Agreement with the European Union. Opposition to the agreement was overwhelming, with 432 members of parliament (MPs) voting against, versus 202 for. It is worth noting that 118 Conservative Party MPs voted against their own prime minister (PM), while only four opposition Labour Party members rebelled and backed the deal.

In reaction to the defeat, Prime Minister Theresa May offered parliamentary time to debate whether the government still enjoyed the support of the House of Commons.

What next?

Theresa May stated that the next step would be to consult cross-party MPs that opposed the deal, to see what changes would be necessary in order to secure their support. The government then plans to put those proposed changes to Brussels in the hope of augmenting the current Withdrawal Agreement.

In order for the EU to be willing to re-open the current agreement, the government must demonstrate that there is sufficient support for the proposed amendments to win a new vote in parliament. Given the multiple issues that parliament is divided on, it seems unlikely that the government can come up with a set of proposals that can change the minds of at least 116 MPs.

If the government persuades parliament to ratify the current or augmented agreement, then the UK will proceed to leave the EU on 29 March, and enter a transition period. During this period, the future relationship including trade, customs arrangements and regulatory alignment should be finalised.

UK recession likely if no deal is reached

In the absence of a deal being ratified, the UK will be leaving the EU without a transition period, and is likely to face significant trade tariffs in accordance with World Trade Organisation (WTO) rules, along with full customs checks, and a number of other important memberships/associations with EU institutions lapsing. Given the fragile state of the UK economy, we would then forecast a recession over 2019.

A delay to Brexit is possible. The UK could request a temporary delay (say three months), but this would require unanimous backing from the 27 EU member states. If the UK has not made progress in securing a majority for a deal, then the EU is unlikely to support a delay without a clear mechanism to break the deadlock in the UK’s parliament. This could come in the form of a second referendum or a general election. As European Parliamentary elections are due in May, the EU is keen not to have the UK’s membership spill over into the new term, unless the UK decides to remain permanently.

If the EU does not grant an extension to the Brexit deadline, then the UK could unilaterally revoke Article 50, only to restart the process again at a later point. This is unlikely and would certainly anger the EU and the public in the UK, especially as it would technically restarts the two-year negotiation process.

High chance of cliff-edge Brexit

In our view, the risk of a “no-deal” or “cliff-edge” Brexit is probably as high as it has ever been. At the same time, the need for a general election or a second referendum to break the deadlock in parliament seems more apparent than ever. Based on the last ten opinion polls of voting intentions, the Conservative Party looks set to retain its position as the single biggest minority party in a general election. However, the Conservatives are projected to lose seats and would therefore need both the DUP and the Liberal Democrats to form a coalition (assuming that both a coalition with Labour and the Scottish National Party is untenable). Moreover, it is worth remembering that opinion polls could shift during a campaign, and we doubt recent events will garner support for the government, even if Theresa May steps down and is replaced by another candidate.

The outlook if a second referendum is called is complicated by the many options possible for such a plebiscite. However, opinion polls that have offered three outcomes: “remain”, “deal” and “no deal” have consistently found that the support for Brexit is split between the latter two, leaving “remain” as the most supported option by a big margin.

Soft Brexit still seems unlikely

We believe that the possibility of a remain result following a second referendum and the prospect of a delay to Brexit have helped boost the pound in recent days against the US dollar and the euro. Markets seem to be pricing in a greater probability of a “soft Brexit”. However, we believe that investors are getting ahead of themselves.

The main uncertainty now is how the Labour party will react. Will the Labour party leader Jeremey Corbyn work constructively with the government to end the deadlock, or will he continue to obstruct the process? The Labour Party’s six tests for Brexit focus on the future relationship, which are irrelevant at this stage of the negotiation. Though not the official position, many in the Labour Party including Shadow Brexit Secretary Keir Starmer and Deputy Leader Tom Watson believe that a second referendum should be the next option.

View from a fund manager

Remi Olu-Pitan, Multi-asset fund manager, says:

The defeat came as no surprise. The market has moved on to Plan B assigning a much lower probability to a "no deal" outcome. While the plethora of options will keep the pound and UK assets vulnerable to headline risk in both directions, the pound and UK assets are already reflecting a significant Brexit premium.

The immediate reaction by EU member states is critical, support for the PM and scope for concessions and a potential extension of A50 will be supportive for the pound and UK assets.

Beyond the near-term volatility, the outlook for UK’s trade relations with the EU remains unclear, this will do nothing to alleviate the risk premium embedded in UK assets.

 

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