The inauguration of Boris Johnson as new PM of the UK marks a next chapter in the Brexit saga.
Clearly, Johnson's main efforts over the coming summer months are to negotiate a new deal to warrant an orderly Brexit on October 31– the date that is currently set as the deadline. With the deadline looming, both the UK and EU find themselves in a difficult situation. In the UK, a large parliamentary majority is against a no-deal outcome, whilst at the same time the majority of the parliament was unwilling to accept the deal that had been negotiated by Theresa May. The EU seems unwilling to adhere to the UK's wishes, but at the same time prefers to avoid a hard Brexit. This situation has been present for some time, and it requires a change in stance by either the EU or the UK to resolve this gridlock.
The political outlook remains highly uncertain, and a wide range of Brexit outcomes is still possible. At this moment, our base case is that there will be some sort of extension, beyond the October 31 deadline. However, given the highly fluid situation we cannot rule out any alternative scenario at this time.
- Orderly Brexit on October 31
The case of an orderly Brexit on October 31 is still a possibility. In that case, the UK would leave the EU about three years after the Brexit referendum took place. For an orderly Brexit to happen, the UK and EU would have to agree on a deal in the coming weeks. Currently, Theresa May's deal is still on the table, but it is unlikely that this deal will be voted on another time or that a majority of MPs will back a deal that had already been dismissed. A second possibility includes a situation where minor changes are made to May's deal, but is uncertain if minor adjustments will convince a majority of MPs to back the deal. A third possibility would be a majorly revised deal, e.g. with changes to the backstop element. For this, the EU would have to change its stance on topics that it named non-negotiable before, and that would have to happen in a short time span.
- Extension beyond October 31
Although Mr Johnson has ruled out an extension, it does remain a possibility. The UK has extended the deadline before, and the EU has indicated it would consider such a request. The extension could be used to renegotiate a deal, but also to hold general elections or to organize a new referendum.
The Prime Minister does not have the authority to call new elections, however Johnson could ask MPs to vote for an early election. In that case, two-thirds of all MPs would need to support the move.
Also, Labour could table a no confidence motion in the new government at any time. If a majority of MPs vote in favour of the motion, a 14-day countdown period starts. If during that time the current government or any other alternative government cannot win a new vote of confidence, an early general election will be called. However, at this time the outcome of a general election would be very uncertain.
When it comes to organizing a new referendum, the parliament has to agree on the type of referendum (binding or non-binding) and on the type of question that is being posed. A new referendum would require new legislation, that would have to define the type of referendum and the question posed. Then, there would have to be a statutory "referendum period" before the Britons could cast their second Brexit referendum vote.
- Cancel Brexit
The European Court of Justice has ruled that it would be legal for the UK to unilaterally revoke Article 50, i.e. to cancel Brexit. This would likely coincide with a referendum or general election, and it would not involve the agreement from the 27 EU countries. It is not clear what the cancellation process would look like, as such a situation has never occurred before.
- Non-orderly Brexit on October 31st
In the absence of a either deal, an extension or a revoked Article 50, a non-orderly Brexit, i.e. a no-deal or hard Brexit, would occur. As mentioned before, a large parliamentary majority is against such a no-deal outcome, however this is still the default outcome if MPs cannot agree on anything else and there are no further extensions.
Leaving without a deal amid political chaos, uncertainties and disruption is probably the worst-case short-term scenario for the UK's economic outlook and, although to a lesser extent, for the EU.
The Brexit vote did not cause a full slowdown of the UK economy, initially. UK growth was decent in 2017 and 2018. This mainly was due to a strong upswing of its main trading partners. These developments are reflected in the labour market as recently the unemployment rate dropped to a 50-year low. These decent growth numbers and strong labour market developments do not mean the UK economy is not affected by the Brexit vote. After all, UK growth has lagged behind most developed markets and the most recent GDP estimates (2019 Q2) revealed that Britain's economy contracted by -0.2%, the worst performance since 2012.
Brexit-related developments, such as stock building - ahead of the original March 29 Brexit deadline - in order to mitigate the effects of a possible disruptive exit, are making UK data volatile. Regardless of the element of inventory overhang, underlying growth momentum has weakened, driven by a slowdown of the global economy – especially manufacturing – and Brexit uncertainty. Survey outcomes suggest that uncertainty over the UK's future relationship with the EU has become more entrenched and that Brexit uncertainty is weighing on business investments.
Financial markets and outlook
We differentiate between various scenarios, some of which have opposing expected market reactions. Generally speaking, a smooth Brexit resolution or an extension to achieve a smooth Brexit resolution can be regarded as positive for risky assets. If Brexit proceeds to some form of deal, market interest rates would likely rise and the sterling exchange rate would likely appreciate. In contrast, a non-orderly Brexit is likely to coincide with lower policy rates, elevated market volatility and a sell-off of risky assets and GBP. Given the highly uncertain situation, and conflicting expected market reactions, we prefer to refrain from specific excessive Brexit risks. In case we do decide to take a position, extra emphasis will be put on downside protection.
Looking ahead, increased uncertainty about the nature of EU withdrawal means that the economy could follow a wide range of paths over coming quarters and years. We expect a hard Brexit to have short-term adverse effects on the UK economy, mainly via the trading- and confidence channels. In case of a soft Brexit or extension, we foresee less idiosyncratic adverse effects, and expect the UK economy to move in tandem with its main trading partners, with risks skewed to the downside on the back of Brexit related uncertainties.