Global Daily – A softer Brexit, or no Brexit ever more likely

by: Bill Diviney , Aline Schuiling

UK Politics: The options continue to narrow – Following the dramatic defeat of the Brexit deal overnight, the UK government is likely to survive this evening’s confidence vote (due at 20:00 CET), and the focus is already on what comes next. We see two main possible scenarios. The first involves a renegotiation of the deal, and the second, a new referendum.

First, Prime Minister May will attempt to reach out to opposition parties to form a consensus approach to renegotiating her deal. While comments from the government so far have indicated that this would not include the main opposition – the Labour Party – an unnamed cabinet minister has suggested that this stance would shift after the confidence vote is cleared. On the EU side, chief negotiator Michel Barnier has said the EU would be willing to renegotiate if the government shifts on its red lines – namely, the one ruling out a customs union with the EU. A customs union would remove the need for the controversial backstop, though as we have previously discussed, such a stance could also lead to a lasting split in the ruling Conservative Party. The Prime Minister therefore has a delicate balance to strike. In addition, the Labour Party would likely put conditions on its cooperation, such as ruling out a ‘no-deal’, extending Article 50 (which is probably inevitable in any case), and potentially a referendum on the final agreement, and/or a general election after it has been ratified. In short, while May’s new approach is potentially a way forward, there any number of ways that it could fall by the way side.

Should the Prime Minister fail to find a consensus with opposition parties and therefore fail to renegotiate a palatable deal for parliament, the next step is likely a new referendum. The opposition Labour Party membership and voters are overwhelmingly in favour of this, and there are also some Conservative Party MPs coming out in favour (Dominic Grieve has tabled a referendum bill which will be debated on 21 January). As the options narrow further, support for a new referendum would continue to grow. Should this scenario pan out, there would be a fierce debate on the question a new referendum would pose, and it would likely be 3-6 months before a vote takes place (2-3 months for the Electoral Commission to test the question format with the public for neutrality, and 2-3 months for the campaign). An Article 50 extension would also be inevitable under this scenario.

In either scenario, the likelihood of a disorderly ‘no-deal’ Brexit is low, in our view. There is little appetite for it in parliament, and polls suggest the public are overwhelmingly opposed as well. As such, we continue to think markets are underestimating the chance of a more benign Brexit outcome, although the recent appreciation of sterling suggests the market might be slowly coming around to this view. We remain positive on sterling. (Bill Diviney)

ECB View: Draghi’s language on economy is shifting – A number of ECB speakers over recent days have sounded more cautious on the economic outlook than set out in the statement following the central bank’s Governing Council meeting in December. In comments to the European parliament yesterday, President Draghi acknowledged that there was a slowdown underway. While in the December press conference, Mr Draghi asserted that ‘the underlying strength of domestic demand continues to underpin the euro area expansion and gradually rising inflation pressures’. In yesterday’s commentary he said that ‘the question we should ask is: Is this a sag or heading toward a recession?… the answer we give is: No, it’s a slowdown, which is not headed toward a recession. But it could be longer than expected’. So the talk of robust expansion seems to have been replaced with more clarity that the economy is witnessing a slowdown, albeit no recession.

We think that the dovish shift in tone will continue going forward, culminating in significant downward revisions in the ECB’s economic growth forecast and a change in forward guidance to signal that interest rates will remain on hold through 2019. We expect economic growth to average 1.1% this year, which is well below the ECB’s current forecast of 1.7%. Our central view is that the ECB will hike interest rates by 10bp in March 2020 and by another 10bp in September 2020. However, the risks to this view are tilted towards an even longer period of unchanged interest rates. (Nick Kounis & Aline Schuiling)