Brexit: financial markets continue to anticipate a smooth outcome

UK Prime Minister May suffered another defeat last week in the House of Commons and right now we have no idea as to what happens next. What we do know is that another vote will be held in Parliament on 27 February. It is still unclear whether this will be merely a vote on another government proposal or the so-called meaningful vote; in other words, the vote on the EU exit agreement. Right now, the first seems the more likely scenario. Although there is theoretically nothing to prevent Prime Minister May from repeatedly presenting her deal to Parliament, she will, however, do her utmost to avoid another defeat. May is therefore unlikely to present her deal unless there is a realistic chance of gaining Parliament’s approval. This is only conceivable under two conditions: either a) the EU makes the concessions required by the UK Parliament or b) Parliament no longer sees any other alternative to avoiding a no-deal Brexit. The first option looks unlikely at the moment, as the EU has made it more than clear that it is not prepared to budge. At the same time, Parliament is not showing any signs of wanting to compromise either. And given that there is still another month to go until the official Brexit day, it is doubtful that Parliament will feel sufficient pressure to agree to an agreement it had previously rejected so resolutely. Hence, the most likely scenario is that May will delay the meaningful vote as long as possible.

It is undeniable that the probability of a disorderly Brexit has increased recently. Although it is quite possible that the UK government will apply for an extension of Article 50, it is not certain that the resulting negotiating period will ultimately translate into success. A potential no-deal Brexit is not yet reflected in the market valuations. Sterling slumped in the immediate aftermath of the referendum in 2016 but has proved to be surprisingly resilient since then. The FTSE 100 continues to follow the sentiment on the global equity markets and there is no indication that government bond yields have built up a significant risk premium. The market therefore continues to anticipate a smooth outcome. A disorderly Brexit would therefore probably have much greater consequences for the financial markets. Sterling would probably suffer a marked depreciation of 10% to 15%. We argued in the past that this could drive the EUR-GBP above par. However, the current vulnerability of the euro (largely the effect of disappointing fundamental data) renders such an aggressive shift more unlikely at the moment. The GBP-USD currency pair is likely to bear the brunt of the adjustment instead and could even ease below USD 1.15, while EUR-GPB could climb to levels of 0.95 to 0.96 sterling. Yields on 10-year UK treasuries are also likely to fall and could ease towards 0.60% to 0.80%, if hopes for BoE interest rate hikes are replaced by speculation about new interest rate cuts as a reaction to the recession, which a no-deal Brexit would inevitably trigger.

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