Brexit: A decisive step into the fog

Published on 16-11-2018 09:23:41

UK PM May’s Brexit deal has achieved the unlikely honour of uniting both pro-EU and Brexiteers in rejecting it. Despite a difficult House of Commons session yesterday, she only reiterated later her role is to finalise the text and bring it back to Parliament for a vote in December. At this point it is difficult to see how she will succeed. A key rival is in the process of securing the 48 letters required for a vote of no-confidence and she has failed to secure a new Brexit minister. Without an election, any new PM would have the difficult task of renegotiating the current deal – and would have to create a credible deterrent of no-deal to succeed. An election risks a Labour government less accommodating to the corporate sector. Both these scenarios are likely to be unwelcome for financial markets. The probability of sufficient change to the draft agreement to pass the UK Parliament appears slim but would in contrast be welcomed by investors.

This is a charged political environment, with personal ambitions interwoven into policies, in addition to the UK national interest.There are material drawbacks to the deal PM May has negotiated with the EU, notably the possibility that the UK could remain in a permanent customs union, unable to exit unless prepared to offer a better scenario – for the EU. That would appear to be a sub-optimal position from which to start negotiating a new UK/EU trading relationship.

Given the expressed view of the UK government that it must deliver on the result of the referendum, its failure to develop a credible no-deal plan over the past two years is surprising. A palatable no-deal scenario would have given the UK’s negotiators increased leverage and possibly avoided the political crisis that is now unfolding. The EU has long established its reputation as a smart and ruthless negotiator, most recently in the eurozone debt crises of the past decade. If the electorate is minded to punish the current administration in future it will be for this lack of foresight, in our view. A credible deterrent has significant value, even if it is never used.

While we note at the time of writing that there have been insufficient letters of support to call for a vote of no-confidence in the PM, a change of leadership would not change the make-up of the UK Parliament, which remains split on Brexit. Should PM May ultimately fail to win support for her deal as expected, it seems the only way forward without a general election would be for any new PM to achieve Parliamentary and public support for a much tougher negotiating position, including allowing for a realistic possibility of a no-deal. It is difficult to see why the EU would materially change its position otherwise. However, this consensus would be difficult to achieve and hardly likely to enthuse financial markets or the non-financial corporate sector, who have to date been supportive of May’s draft proposal in recent days.

If such a consensus cannot be achieved, a general election becomes likely in Q1 19, which in effect would represent a second referendum on a strategy for Brexit. Investors in these circumstances would have to contend with the meaningful probability of a Labour administration, which would be likely to be significantly less accommodating to the corporate sector, a situation also unlikely to enthuse UK financial markets. Within this scenario there are likely to be calls to extend Article 50 and/or remain in the EU, thus increasing uncertainty. In contrast, the probability of sufficient change to the draft agreement to pass the UK Parliament appears slim, but would in contrast be welcomed by investors. We believe UK markets are likely to remain volatile in the circumstances.

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