Global Daily – Revised Brexit Scenarios

by: Bill Diviney , Georgette Boele , Aline Schuiling

UK Politics: New leadership raises no-deal risks – Following the decision by PM May to resign, and the start of a new leadership contest in the Conservative Party (see below), we have reviewed our Brexit scenarios and now see a no-deal Brexit as somewhat more likely than previously – a 25% probability vs 15% previously. Whichever leader takes over (the most likely at present is Boris Johnson), he or she will almost certainly be more comfortable with a no-deal Brexit than PM May was. As we have seen in recent months, there are mechanisms for Parliament to block a no-deal Brexit, but those options are considerably narrowed if the government fails to even bring a deal to parliament (as looks increasingly likely). In this scenario, the only way to avoid no-deal would be through a vote of no confidence – something Conservative Party MPs may struggle with, as this would lead to an election, and opinion polling suggests this would be a disaster for the party.

Below, we set out our new Brexit scenarios, and the potential pathways to each outcome.

Deal/Soft Brexit: 40% (previously 45%) – This can happen two ways. First, a new Conservative PM might be able to negotiate different, more acceptable terms for the withdrawal deal, perhaps by removing or adding a time limit to the backstop. This is unlikely to succeed, however, based on the EU’s response to such manoeuvres so far. This failure could lead to the new PM adopting a policy explicitly advocating ‘no-deal’. As there is a majority in parliament against no-deal, a no confidence vote would bring down the government, triggering a general election. This would be brutal for the Conservatives given the right-wing vote is now split with the Brexit Party, meaning a Labour-led government which pursues a soft Brexit with customs union membership (the second possible type of deal).

Remain: 35% (previously 40%) – A future Labour-led government could offer a referendum on a potential soft Brexit deal, as significant numbers of Labour MPs support a referendum, as does a majority of the party membership. This would be even more likely if Labour needs to form a coalition with the Remain-supporting Liberal Democrats and/or SNP. Should a referendum take place, opinion polling suggests Remain would win vs a deal and/or no deal options, whether in a two-way or a three-way referendum. A further route to a Remain outcome is if parliament, faced with no-deal and the EU refusing to offer a further extension, revokes Article 50 (the ‘nuclear option’).

No deal Brexit: 25% (previously 15%) – Despite the parliamentary majority against no-deal, it is possible that Conservatives fear a Labour government headed by Jeremy Corbyn more than they do no-deal, and therefore fail to bring down the government in a no-confidence vote. In another scenario, the Conservatives and the Brexit Party could enter a pact in a new general election to address the split in the pro-Brexit vote, leading to a potential electoral win for the Conservatives and a coalition with the Brexit Party. Should they campaign on a no-deal platform, a new, more pro-Brexit parliament might allow no-deal to happen.

Leadership contest timetable – The leadership race officially kicks off on Monday 10 June, and nominations will close that week. Through successive rounds of voting, MPs will whittle down the candidates to two options, which are then put to the Conservative Party members (c.124,000 people). Members currently overwhelmingly support Boris Johnson according to polling, but opinions could shift as the contest gets underway. The parliamentary process should be over before the end of June, meaning a new Prime Minister should be in place by mid-July. (Bill Diviney)

FX View: Further near-term downside in sterling – In recent weeks (since the start of May), sterling has dropped by 4% versus the US dollar and euro. This steep decline has been the result of market expectations that Prime Minister Theresa May would resign, and Boris Johnson would become the new Conservatives’ new leader and Prime Minister. Investors hold the view that if he takes over the probability of a no-deal Brexit would increase. Meanwhile, Theresa May has resigned and the battle of who will take over has begun. As stated above we have also adjusted our scenarios to reflect a less optimistic outcome. In the futures market, the speculative community holds a modest net-short position (cut-off last Tuesday) but this position is likely understated as sterling has weakened further. We expect the political and Brexit uncertainty to continue to weigh on sterling. In the near-term GBP/USD could drop towards this year’s low of 1.2441 and EUR/GBP could rise towards 0.90-0.91. We do expect a recovery in sterling when the political situation improves but that may take some time. (Georgette Boele)

Euro Macro: Bank lending to companies to slow down – Bank lending data that was published by the ECB today showed that the monthly flow in loans to non-financial companies bounced back in April (to EUR 24bn) after it had declined (to EUR 8bn) in March. The flows are adjusted for sales and securitization, but nevertheless are volatile on a monthly basis. The less volatile annual growth rate picked up as well, increasing to 3.9% in April, up from 3.6% in March. It has been hovering between 3.5% and 4% since the start of the year, which is somewhat lower than during the second half of last year. We expect the growth rate in loans to companies to ease further in the coming months. Indeed, it tends to follow changes in GDP growth with a delay of around one year and the slowdown in loan growth since the start of the year seems to reflect that GDP growth has declined since the start of 2018 and fell to below the trend growth rate in the second half of last year. Looking forward, we expect GDP growth in the eurozone to return to below the trend rate in the next few quarters, after it was lifted by some one-off factors in Q1 of this year. Therefore, growth in bank lending should slow down as well. (Aline Schuiling)