Economics & Growth | Politics & Geopolitics | UK
Finally, some meaningful progress on Brexit! MPs have voted through the Withdrawal Agreement Bill. But not everything went the government’s way. They have insufficient support to rush the legislation through by 31 October. This means that the bill’s progress is now suspended pending an announcement from the EU on what length of extension it will grant in order to pass the legislation…
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Finally, some meaningful progress on Brexit! MPs have voted through the Withdrawal Agreement Bill. But not everything went the government’s way. They have insufficient support to rush the legislation through by 31 October. This means that the bill’s progress is now suspended pending an announcement from the EU on what length of extension it will grant in order to pass the legislation.
Prime Minister May never got this far, despite holding three votes on her deal. So, while there has been some disappointment in financial markets that the process is paused, the fact that Brexit (with a deal) is a step closer should be a positive for the economy. Investment in particular has suffered under the perpetual uncertainty over the trade arrangements. The BoE Agents survey saw Q3 investment intentions fall to their lowest level since January 2010 (Chart below), so there is now some optimism that the withdrawal from a no-deal will unlock some of this delayed spending.
How Much Certainty Does a Deal Buy?
The situation remains fluid, as evidenced by the pause in proceedings. And if Brexit has taught us anything, it is to doubt the next steps will be straightforward. A longer debate on the Withdrawal Bill will probably engender multiple attempts to amend it. Another general election is also on the cards.
All this is hardly a respite for those of us trying to peer through the fog of uncertainty.
Even a fairly smooth passage through to a transition period will only provide temporary reprieve: the transition period itself is only scheduled to last until the end of 2020. This could rapidly become the next point of uncertainty, not least because if no trade deal with the EU has been concluded, the UK could still effectively end up with a no-deal Brexit. The sheer complexity of the issues surrounding the next phase of negotiations, the discord between UK politicians, and the failure to stick to deadlines means that confidence in the political process will remain extremely fragile. This is likely to limit any near-term recovery of business sentiment.
The BoE’s Three-Way Switch
The market firmly believes that that the next policy actions from the BoE are almost entirely dependent on Brexit. A ‘no deal’ would lead to a near-term aggressive easing of policy; an extension of Article 50 would lead to rates remaining on hold; meanwhile a deal would, in time, allow the MPC to continue their policy normalisation. The MPC has been keeping its powder dry in case of a no-deal Brexit, but the market should be wary in assuming that a decrease in those risks equates to a significantly reduced probability that the BoE will ease policy. Indeed, the risk that the MPC is forced to cut rates looks high:
• A recession may have been avoided, but the domestic economy is struggling to achieve a growth rate much in excess of 1%. Looser fiscal policy, with the BoE expecting to add 0.4% to GDP over the coming 2-3 years, should provide some support. However, the PMIs were all below 50 in September and there are signs that the labour market is starting to soften. This would weaken consumer expenditure, the key driver of economic growth. A string of high-profile corporate failures such as Thomas Cook, only adds to the sense that all is not well in UK plc.
• The global growth backdrop continues to deteriorate with the IMF being the latest institution to downgrade its growth forecasts from 3.3% to 3% in 2019. Concerns over the impact of trade wars and whether the US will enter recession continue to dominate market thinking.
• The global trend has been the resumption of central bank policy easing. The ECB’s actions, in particular, are unlikely to be lost on the MPC.
The breaking of the Brexit deadlock is probably an insufficient pre-condition to unlocking a pipeline of investment spending. The MPC is increasingly aware that prolonged uncertainty is proving detrimental to the health of an already ailing economy. This is likely to be reflected in the BoE’s November forecasts and Inflation Report (7 November). The forecasts are currently based on the UK achieving some sort of deal, but the Canada plus plus deal sought under the new Johnson Brexit is perceived to be significantly less favourable for growth than the terms sought under the May deal.
The success of the Brexit vote has pushed the MPC dated SONIAs to price an 80% probability of a 25bp rate cut by the end of 2020. However, current economic weakness against the backdrop of persistent uncertainty suggests that a rate cut could be far closer than that.
Figure 1: Brexit Uncertainty Dampened Investment Intentions
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.
(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.)