Brexit: Buying time
What a week. What a roller coaster ride in British politics! British Prime Minister Theresa May has finally succumbed to pressure from the majority in parliament that wants to retain close ties with the EU. Earlier last week, she announced that parliament would decide whether the UK should seek a delay to Brexit if it has not backed a Brexit deal by March 12. This materially alters the economic and political outlook for the UK. Also, the shift in the Labour Party’s stance to move back a second referendum without a ‘no deal’ option made headlines. Markets think that with providing a mechanism to delay Brexit, May has un- dermined the threat of a hard exit as a negotiating tactic. Still, the hard Brexit risk is not yet completely off the table. It remains the default option now, or at the end of any extension, unless a deal is agreed by the UK and the EU or unless the UK unilaterally withdraws its decision to leave the EU.
While Brexit seems likely to lower the pound’s ‘fair’ value, with the extent dependent on the sort of Brexit, most traders and investors will probably just focus on the extent to which the pound has fallen since the referendum in 2016, and assume that a fair proportion of this slide can be made up once a deal is done. Assuming the dreaded no-deal exit can be avoided, those that have hedged their export revenue (UK firms) or UK assets (foreign investors in the UK) just in case of a no-deal debacle, will probably unwind these hedges, and sterling will rise as a result. After all, market watchers agree that sterling isn’t very attractive at all given the economic and political outlook for the UK. The likelihood that Brexit will be delayed, along with the increasing chance of a second referendum or snap election, further raises the already-elevated difficulties in forecasting the UK economy over the medium term. Nevertheless, the simultaneous decline in the risks of a hard Brexit and a Corbyn-led government are unequivocally positive for financial markets and the UK’s long-run economic outlook.
Delaying the Brexit date without a proper resolution would merely extend the current uncertainty that is weighing heavily on domestic demand. According to Berenberg forecasts, the real GDP will be around 1.4 percent in 2019, 2.1 percent in 2020. A longer extension without a resolution would further delay an eventual rebound in demand growth.