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Brexit - What's Next?

IMPORTANT

  1. The following presentation has been finalised after the Brexit Party’s decision yesterday not to stand in the 300+ constituencies that are currently in the hands of the Conservative Party. Nigel Farage’s decision caused me to make a few changes. For example, on page 4, I increased the probability of Johnson’s withdrawal agreement being passed by Parliament from 65% to 75%.
  2. If Nigel Farage bow’s to the ongoing pressure from senior Conservative politicians to also stand down in marginal Labour constituencies, I will raise that probability further.
  3. Having said that, I should point out that anything to do with Brexit has proven notoriously difficult to predict. Please bear that in mind when reading the following.

Since becoming Prime Minister, Boris Johnson has attracted support at the expense of the Brexit Party.

UK General Election: Vote Share by Opinion Poll
Source: Goldman Sachs Investment Research

Boris Johnson’s withdrawal agreement stands a good chance of being passed by Parliament if the Conservative Party can win a few additional seats on the 12th December.

Choice of Brexit Deal
Source: Goldman Sachs Investment Research

I see three possible outcomes of the forthcoming general elections with a conservative majority government being the most likely.

Short-Term Implications of Brexit (which in reality are entirely unpredictable until we know which version of Brexit we end up with)

The UK Financial Conditions Index continues its ‘disorderly’ behaviour, depending on the latest political developments.

UK Financial Conditions Index since Brexit Referendum
Source: Goldman Sachs Investment Research

The combination of weak UK demand and deteriorating economic conditions worldwide has caused the BoE to reduce its growth projection for 2020-2022.

BoE's GDP Forecast
Source: Bank of England

… whilst it expects CPI to rise modestly due to rising unit labour costs, and that is indeed a bad combination.

BoE's CPI Forecast
Source: Bank of England

Long-Term Implications of Brexit

The populists continue to argue that Brexit is worst for the EU, but they ignore the fact that only 7-8 % of EU exports go to the UK vs. 45% going the other way …

Impact on EU-UK Trade
Source: Oxford Economics

… and the implications are obvious. Only the Irish economy will take a significant hit, whilst the rest of the EU will hardly notice it.

Average across scenarios
Source: Oxford Economics

Overall GDP growth will be much more negatively affected long term, if ERG and/or Nigel Farage get it their way.

UK: Impact of Brexit on Level of GDP in 2030
Source: Oxford Economics

Oxford Economics’ work on long-term Brexit implications is the most detailed I have seen yet, and I would encourage you to view this presentation (3 minutes only).

My take:

Assuming Johnson’s withdrawal agreement is passed by Parliament …

  1. … a relatively short-lived relief rally in £ and UK equities will materialise.
  2. On the other side of that rally, another lengthy period of uncertainty will begin to unfold as the withdrawal agreement is only the beginning. After that comes the trade agreement which could take years to negotiate.
  3. During this phase, I would expect £ to remain comparatively weak …
  4. … which is good for UK export companies but bad for domestic demand, given the high proportion of imported goods in the average consumer basket.
  5. The net result is most likely a relatively weak British economy, at least until those trade negotiations have been finalised, and after that it will depend on the nature of the trade deal …
  6. … which should lead to a relatively friendly BoE – at least for another 2-3 years. Low interest rates will allow BoE to pursue a policy of debt destruction through inflation at the same time.
  7. The most likely event to lead to a different outcome than the one described above is a second referendum, and that we reverse the earlier decision to leave the EU.

One implication of the Brexit mayhem is that persistently modest GDP growth could force the BoE to think out-of-the-box. One distinct possibility is the introduction of digital money.

The Value of Notes and Coins in Circulation in the UK (% growth)
Source: Bank of England

Another implication could be a change of the electoral system. Could the first-past-the-post model be ditched? Such a change will take time but never say never.

UK Vote Share - Realised and Projected
Source: Goldman Sachs Investment Research

Niels C. Jensen

12 November 2019

About the Author

Niels Clemen Jensen founded Absolute Return Partners in 2002 and is Chief Investment Officer. He has over 30 years of investment banking and investment management experience and is author of The Absolute Return Letter.

In 2018, Harriman House published The End of Indexing, Niels' first book.