Nomura

New Year, New Brexit?

  • The uncertainty of Brexit has weighed on UK consumer confidence, business investment and UK markets.
  • The market longs for some sort of Brexit clarity. What do the 3 options of deal, no deal, and no Brexit mean?

Remember hard but think soft

The market assigns a higher probability to a hard Brexit than we do. We are aware of it as a possibility, but deem parliament’s ability to find a majority against it would be a powerful force. We are also slightly higher than the market in looking for a soft Brexit/Remain outcome. It’s the “deal or something else” that is slightly misleading. This is a “catch all” outcome, i.e. it includes the probability of the deal being agreed to in parliament either in its current form or something else. There are no market expectations for this scenario, but by process of elimination, it is roughly around the same level we expect in probability around 50/50. We make that call based on the assumption Prime Minister May secures something from the EU that could convince moderates in the Conservative party to vote for her deal.

What will happen over the coming months?

What do we expect to happen next?

If a deal is agreed we would expect growth to run at 0.3-0.4% per quarter over the forecast horizon, inflation around target and the BoE raising rates twice per year, beginning in May.

No deal is a difficult endeavour to forecast for as market reactions may become non-linear. The BoE’s own analysis puts the economic hit between -4.75% and -7.75% depending on how disorderly the Brexit would be and could result in sharply lower sterling, higher inflation in the near term (thanks to the move lower in GBP and the introduction of tariffs on EU imports), lower consumer spending growth, falling business investment and generally reduced confidence would likely give way to a recession of some sort. Government spending would be in place to help lessen the impact, but would not outweigh the drag from elsewhere, and owing to lower growth the deficit would widen markedly. Two quarters of negative growth would likely follow, but politics would still play a large part of what happens next as it could mitigate the economic impacts by making deals later on with the EU.

Another referendum could be a market positive as it increases the chances of remaining in the EU; as a result a higher GBP would follow. But it would also mean prolonged uncertainty and weaker consumer spending and investment in the very near term (relative to our base case). The BoE would likely delay the first hike until after the referendum, but then our forecast of two hikes per year would be on more solid ground following the vote to remain.

Can Brexit defy gravity?

Or in other words, would a departure from the customs union be economically advantageous from a trading perspective?

A key argument among Brexiteers is that departure would allow the UK to craft its own, more tailored, trade deals with faster growing non-EU countries. However, the countries with which departure from the customs union would open up trade are typically further away geographically – a fact that so-called “gravity models” suggest could be highly limiting when it comes to boosting trade. The negotiations with the EU are one of the few examples in history where a free trade negotiation ends up installing new barriers to trade rather than removing them. The Brexiteers would argue that gravity models are flawed, but they just represent the facts. You don’t need models to see that countries that are close together have higher levels of trade.

What our clients are expecting to happen

We conducted a survey at the end of 2018 to find out what people think will happen as we move into the New Year.

Results of the client survey (Dec, 2018)

For more information read The Brexit Guide for 2019.

Contributors

  • Jordan Rochester

    FX Strategist

  • Alina Zaytseva

    FX Strategist, EMEA

  • Yujiro Goto

    Senior FX Strategist

  • George Buckley

    Chief UK Economist

  • Sam Bonney

    Macro Strategy Research

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