Brexit: Credibility Questioned (3 min read)

The political twists and turns of Brexit just keep coming. Prime Minister Boris Johnson clearly upped the stakes when he announced that Parliament would be prorogued (shut down) until 14 October. Those opposed to Brexit without an agreement in place have hit back, pushing through a bill that will force the Prime Minister to call for an extension if there is no deal in place by 19 October. The PM has countered by saying that he will not request an extension and that the only way to break the deadlock is through another general election.

The Conservatives are currently ahead in the polls with around 32% while Labour and the Lib Dems are polling in the 20-25% range. So the Conservatives look likely to remain the single largest party but unable to command a majority. This would only be possible if they campaigned for a No Deal Brexit, which would attract a large slice of the Brexit party vote (currently 12-14% in the polls). The alternative would be some sort of coalition focused on Labour, but most parties are loathed to support Jeremy Corbyn given his rather radical views.

The way ahead looks unclear and faith in the political class has evaporated. Importantly, this political uncertainty is having a clear impact on growth – Q2 GDP was negative and the collapse in the August PMIs suggests limited chance of a near-term recovery.

 

Rules Are There to Be Broken

The continuing political chaos will not be welcomed by overseas investors but all parties in parliament share responsibility for the upheaval. Perhaps, just as damaging will be the slide towards populism of the Conservatives who position themselves as the party of business and sound economic management.

 

  • The Conservative’s apparent willingness to accept a No Deal Brexit clearly raise questions about their economic management credentials.
  • Other areas of credibility, such as around fiscal policy, are also under threat. The Chancellor Sajid Javid, on Wednesday, announced the latest spending round which saw a 4.1% real terms rise in public spending. The Institute for Fiscal Studies has suggested that ‘it will be touch-and-go whether the Chancellor will meet his fiscal targets in the Budget later this year, even with a smooth departure from the European Union’. The UK’s borrowing is by no means excessive but the fact that spending has been ramped up, despite a lack of clarity on Brexit, does suggest a more overtly political approach.
  • The rulebook seems to get re-written on a daily basis. Whether you look at the anarchy in parliament or the fact that the Chancellor has said he will be reviewing the fiscal framework (in itself is a warning that it is likely to be breached) the image of a well ordered society is fast diminishing.

 

Watching From the Sidelines

This gradual descent into chaos is likely to impact overseas demand for gilts. The Chart below shows the 6m average of overseas purchases of gilts and it is clear that political, as well as monetary policy, events matter. There was a buyers strike into the 2016 EU referendum with the resulting underweight position then having to be covered as the BoE moved to ease policy. Flows during 2019 have been volatile with heavy net selling (£17.8bn) during the first two months of the year, but once again, this was followed by short covering in March (£10.4bn) as it became clear that the UK would not be leaving the EU on time. The weakness of Sterling may encourage some international buyers of gilts as they seek to maintain their portfolio weightings, but there is likely to be a movet to reduce exposure to UK assets. The fact that the UK 10y has underperformed both Bunds and US Treasuries since early June hints that this process may already be underway.

Chart 1: Overseas Purchases of Gilts: 6m Average

Purchases of Gilts

Source: BoE Bankstats data, Macro Hive

Jason has been a sell-side rates strategist for over 20 years. During his career, he has predominantly focused on the UK, but he also looks at markets from a global perspective. He can be reached here.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)

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