Boris Johnson managed to agree amendments to the Brexit deal with the EU in October and appeared to have momentum to push it through the UK parliament. It was given initial approval to proceed but his plans came unstuck when lawmakers wanted more time to inspect the detail and propose amendments, forcing him to ask the EU for an Article 50 extension and break his promise that the UK would leave the EU by 31 October. With no-deal Brexit off the table, for now, Parliament agreed to a general election in December, the results of which will be integral to determining when and how Brexit can proceed.
Johnson negotiates amended Brexit deal
Having spent considerable time since the start of his premiership warning that the UK would leave the EU "come what may" and without a deal if the EU failed to offer the concessions he wanted, it appeared that Boris Johnson was happy to count down the days to a no-deal Brexit on 31 October. He was, however, forced to get serious about negotiations when the UK parliament introduced a law forcing him to seek an extension to the UK's membership of the EU if no deal could be agreed and approved by the UK parliament.
With days to spare before the imposed deadline of 19 October, the UK and EU negotiators managed to draw up an alternative solution to the "Irish backstop", the insurance policy required by the EU so that no hard border is needed between Northern Ireland and the Republic of Ireland, independent of the long-term relationship which the UK decides to pursue with the EU.
This solution, along with other amendments (including transferring the intention to maintain environmental and workers' rights from the legally-binding Withdrawal Agreement to the non-binding Political Declaration) was enough to win over many pro-Brexit Conservative Members of Parliament (MPs). Several Labour MPs, particularly those sitting in pro-Brexit constituencies, were also prepared to vote for the bill.
Figure 1: Future Brexit timeline. Source: Aegon Asset Management. The Withdrawal Agreement contains the terms on which the UK leaves the EU. The transition period is intended to offer time for the UK and EU to negotiate a future trading relationship. During the transition period, the UK would maintain its current trading relationship with the EU and follow EU rules but would have officially left the EU and no longer participate in the EU's legal and decision-making processes.
General election called
However, the slim majority fell away when it came to the proposed timetable for approving the deal, which would only have given Parliament a few days to debate and amend the legislation. This meant there was no option but for Johnson to request an extension from the EU. He also decided to pause the legislative process, making clear that he believed a general election was the only way to resolve the impasse.
Once the EU had offered an extension to 31 January 2020 (with the option to shorten it if the agreed deal could be approved in the meantime), opposition parties were more comfortable voting for an election which will now take place on 12 December 2019.
What to expect once the UK leaves the EU
Assuming the current Brexit impasse is resolved and the UK leaves the EU by 31 January 2020 with the proposed Withdrawal Agreement, a transition period will then begin. This period is intended for negotiations over the future trading relationship between the UK and the EU. The initial transition period was set until 31 December 2020 but can be extended for one or two years, if agreement is reached to do so by 1 July 2020. With the previous extensions to the Article 50 period (which originally ended in March 2019), the transition period would now be much shorter than originally envisaged.
Trade negotiations are complex processes and, given the shortened potential transition period, there is a risk that no agreement will have been reached by 1 July. Whilst the Withdrawal Agreement would have dealt with certain aspects of the UK's departure, there would remain the risk that, without an extension, the UK would revert to trading on World Trade Organization rules at the end of the transition period.
This would represent a new trade risk for the UK and EU economies, much like the risk of a no deal Brexit on 31 October 2019 before the arranged extension. Whilst the UK parliament then had a majority against no deal Brexit, it may be that the new parliament will not. This would therefore increase the risk of the UK not requesting an extension to the transition period.
Potential election outcomes
Parties require around 322 seats to form a majority government (dependent on the number of seats held by Sinn Féin). The composition of the House of Commons, the UK parliament's lower, elected house, could change significantly as a result of this election with several different outcomes possible. Figure 2 shows the current composition.
Source: parliament.uk and Aegon Asset Management, as of 5 November 2019. The total of 642 seats excludes those held by the Speaker of the House of Commons (non-voting) and 7 seats held by Sinn Féin who abstain as they do not recognize the UK Parliament's right to legislate for Northern Ireland.
Conservative party majority
According to opinion polls at the time of writing, this is currently the most likely outcome. With a reasonable majority, Boris Johnson would likely be able to pass the agreed deal through Parliament and then enter the transition period until 31 December 2020.
This period is intended for negotiating the future long term trading position with the EU. However, in appealing to pro-Brexit voters, the Conservative party are already indicating that they do not wish to extend beyond this date which would risk reaching the end of 2020 with no or limited trading arrangements in place.
Conservative party minority government supported by minority parties
The Brexit Party, a new pro-Brexit party, were not represented in the last parliament but were the largest party at the European elections in May. They are not standing candidates in seats held by the Conservatives but, if they do win other seats, the Conservatives may rely on their support to form a government. Depending on their influence, this would be likely to increase the risk of a hard Brexit.
The Conservatives were supported by the Democratic Unionist Party (DUP) in the previous parliament. However, this arrangement could prove very difficult to maintain in future, as the DUP are opposed to the changes Boris Johnson made to the Withdrawal Agreement in order to solve the issue of the Irish backstop.
Labour party majority
Assuming the EU agreed, the Labour party's policy is to renegotiate the Withdrawal Agreement to develop a closer relationship with the EU. This would require a further extension of the Article 50 period. Labour then proposes a second referendum on the deal they have negotiated. The whole process may take several months.
No overall majority
This outcome has a reasonable chance given the current composition and the even split of the referendum vote. The consequences for Brexit will be very dependent upon whether there is a majority of MPs across parties for a particular option e.g. for Boris Johnson's deal or for a second referendum. If the stalemate continues, a second referendum potentially becomes more likely if more MPs decide that, even after an election, Parliament will not be able to resolve the impasse.
The result of the referendum vote of 2016 has not been catastrophic for the UK economy although there is evidence of lower growth compared to its pre-referendum trend. It has also lagged many developed countries in the subsequent period.
UK GDP has continued to grow with the exception of Q2 2019, when the economy contracted by 0.2%. This is likely to have been influenced by increased stockpiling in the build-up to the first Brexit date at the end of March 2019. In Q3 2019, the UK economy grew by 0.3%, giving an annual growth figure of 1.0%, its lowest level since 2010.
Source: Refinitiv Eikon and Aegon Asset Management to 11 November 2019. 1: Brexit referendum result, 24 June 2016; 2: Deal agreed between EU and Theresa May, 14 November 2018 ; 3: Theresa May resigns, 24 May 2019; 4: Boris Johnson wins Conservative leadership, 23 July 2019; 5: Amendments to Withdrawal Agreement agreed between EU and Boris Johnson, 17 October 2019; 6: General election date of 12 December 2019 finalized, 31 October 2019.
However this story of low but maintained growth has not been true of every sector. Construction has been particularly badly hit whilst within services, the largest sector of the UK economy, financial services have also struggled.
Financial markets outlook
Brexit risk is most immediately seen in the strength of the pound. Sterling responded positively to news that a new deal had been agreed with the EU and the potential for it to pass the UK parliament. It also reacted positively to the subsequent extension and the announcement of a general election as these reduced the chance of a hard Brexit and also brought the potential for more certainty about how Brexit will proceed.
Sterling is likely to respond well to any election outcome that gives more certainty and reduces the short-term risk of a hard Brexit. Of course other factors will also be of influence, including the expected fiscal policies of the parties.
UK-listed equities have also suffered underperformance relative to their developed market peers since the referendum result. Since 2015, developed market equities have grown around 40% in euro terms whilst the UK market has only managed around 15% . Whilst some of this can be attributed to the composition of the indices and the weakness of sterling, there is also evidence of "unpopularity" of UK-listed stocks, despite the UK stock market being very international in nature. A Brexit resolution which gives future certainty for the longer-term stability of UK-listed stocks may support some reversal of this underperformance.
The results of the UK general election on 12 December are likely to be crucial in determining how Brexit proceeds. However, even if, as the polls are currently predicting, the Conservative party wins a majority and the deal Boris Johnson has agreed with the EU can be approved by the UK parliament, this is unlikely to be the end of the Brexit story and its impact on markets and the economy.
The next stage will be negotiations over the future trading relationship between the UK and the EU which could well create further uncertainty and risk. If no agreement on this relationship is made, there could be risk of a further cliff edge in the Brexit process at the end of 2020, when the initial transition period is currently set to end.
For markets, an orderly Brexit and subsequent trade negotiations are the most positive short-term outcomes and are likely to lead to some recovery in sterling and risk assets impacted by the Brexit uncertainty, other things being equal.