Sterling's roller-coaster ride not over yet as Brexit mayhem continues

Doubts over the success of a UK deal to leave the European Union is swaying its movements

The balance of risks certainly appeared to turn to the downside for sterling last week as the UK government’s proposed deal with the European Union was met with almost universal disapproval from both Show more

Last week felt like sterling’s worst nightmares were about to happen with the prospect of a no-deal Brexit seemingly coming into view, pushing the pound down from $1.30 to $1.2840 at the end of it. However, the reality is that the whole Brexit saga underway since the summer of 2016 will probably still have more months to run, and with it a very complex series of political twists and turns. At the end the chances of extreme outcomes on either side of the debate are actually fairly evenly balanced, which is why for all the volatility in the pound it ended the week only a little lower than where it started and still within the range of the last few months.

The balance of risks certainly appeared to turn to the downside for sterling last week as the UK government’s proposed deal with the European Union was met with almost universal disapproval from both sides of the Brexit debate, and resulted in prominent resignations from the Theresa May government. The chances of the UK government collapsing were seen to rise, and certainly the prospect of Mrs May getting her Brexit deal passed through parliament was perceived to be extremely low. However, whether this actually ends up with the UK leaving the EU without some form of deal depends on numerous factors. In fact whether it means the UK leaves the EU at all still remains an open question, as last week’s events may actually have strengthened the possibility of another referendum, which if it happened would almost certainly result in a decision to remain in the EU.

Mrs May managed to rebuild her Cabinet at the end of last week, which in the short term means that the threat of a leadership challenge may have abated, especially as her opponents failed to generate enough votes to force a vote of no-confidence. Providing the EU summit on November 25 approves the deal, which seems likely, the next stage of the process will likely be a UK Parliamentary vote in December. The assumption at this stage must be that it will fail to get the required number of votes, with both ‘Brexiteers’ and ‘Remainers’ both unhappy with key elements of the deal, seeing it as an unsatisfactory half-way house. However, following any rejection of it in December there could be a number of outcomes which would still leave Britain’s future unclear all the way to the end of March, and maybe even beyond.

____________

Read more:

The issues behind the latest market sell-off are unlikely to disappear

Oil price could remain high for some time

Are we ready to handle the next financial crisis?

Looming US political risks pose a real threat to the markets

____________

These could include for the UK to seek to renegotiate parts of the exit deal and for it to be eventually passed; for the UK to leave the EU without a deal at the end of March; for the government to collapse and a general election be called; or perhaps most controversially for another referendum to be called to break the parliamentary logjam. The last two possibilities would take time, and may need an extension to Article 50 by the EU which could take the issue beyond the March 29 deadline. Ironically, while the markets focused on the negatives of a no-deal Brexit, it may be that another referendum could actually become the more likely outcome, which could reverse the whole process and be undoubtedly positive for sterling.

Finally, much of the negativity that surrounds the issue of leaving the EU without a Brexit deal reflects the emotive language with which it is described in terms of the UK ‘crashing out’ of the bloc. Undoubtedly, there will be negative consequences, especially in the short-term if the government is unable to engender confidence in its emergency plans. At the moment this looks doubtful especially if Brexit takes place against the background of a disorderly change of government. But in the end, trading with the EU on World Trade Organisation terms may not be as disastrous as many anticipate, especially if it allows the UK to also trade more freely with the rest of the world. And it should also not be overlooked that with the UK’s economy one of the strongest in Europe at the moment this stands it in relatively good stead to at least cushion some of the blows of Brexit, if that is indeed how things turn out.

Tim Fox is the chief economist and head of research at Emirates NBD