May’s Brexit plan: clarity at last
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People and MarketsComment

May’s Brexit plan: clarity at last

City of London

Ever since Theresa May became UK prime minister in July, markets and commentators have thirsted to know what her strategy would be for the negotiations to leave the European Union. Now we know — and so far, the markets like it.

Just as when Donald Trump made his presidential acceptance speech on November 9, the UK's prime minister Theresa May recaptured the initiative on Tuesday, soothed many of investors’ worst fears and painted a picture of the future that they can live with.

There will be many very difficult patches ahead over the next two years of Brexit negotiations, and plenty of volatility. But unless there is a strongly negative reaction from EU leaders, there is a good chance that the next few weeks could be placid on the Brexit front.

That augurs well for capital markets activity in the first quarter of 2017 — such as the IPO pipeline, which is much more sensitive than debt markets to bad news.

More importantly, the medium term outlook is calmer than before May spoke. Enormous uncertainty cannot be avoided, with Brexit. But investors can now begin to discern the scope of that uncertainty and visualise the potential outcomes more clearly.

UK equities are worth 1.2% less than they were this morning, after May set out her plan in a speech at lunchtime — making it clear that Britain would leave the European Single Market and the Customs Union.

But in dollar terms, the FTSE All Share Index is worth 1.5% more. The pound’s sharp rise this afternoon, by 2.8%, is its strongest gain since the referendum on June 23 and breaks a long slide in the currency since early December.

Parliamentary vote a sideshow

FX analysts who watch the market like hawks were quick to attribute that to one hard nugget of new news they found embedded in her speech, which to them seemed to contain few surprises. This was May’s declaration that the final deal on Brexit would be put to Parliament for a vote.

But the idea that this justifies such a strong rally in sterling, on the reasoning that Parliament will restrain May from the hardest of Brexits, is absurd.

Such a vote, which had anyway been widely expected, would take place after two years of stressful negotiations with the other 27 EU member states. The idea that Parliament could, at the eleventh hour, throw out the Brexit deal May has negotiated is fanciful. The vote is important for constitutional reasons, but will just rubber-stamp the deal.

To the extent that Parliament does flex its muscles, that will introduce uncertainty and hence is likely to be bearish for sterling. So the pound has not rallied because Parliament might block Brexit.

Back from the precipice

A more convincing explanation is that traders were encouraged, or at least relieved, by May’s words. When it became clear sterling was not going to drop further into the abyss below $1.20, as the gloomiest had feared, all those positioned bearishly had to cover their shorts and the pound steamed upwards.

Experts who had already worked out from leaks and hints what kind of Brexit May was going to pursue may see little to cheer in her speech.

Berenberg, for example, said “on the economy, we learned nothing new”. It reiterated its view that UK potential GDP growth was now 1.8% a year, down from 2.2% before the referendum, adding “May’s fighting talk somewhat raises the risk of a harder Brexit than our base case assumes, risks to long term growth are thus tilted to the downside”.  

Equally, those who are convinced leaving the Single Market will wreck the UK economy have had their fears confirmed. Algebris Investments puts the cost of a hard Brexit at £140bn, or 7.5% of GDP.

Reducing uncertainty

But the picture markets see is often one of broader brush strokes. Since Trump’s election, investors have ignored his wild vacillation on policy and the lack of clarity around any of his proposals, and been swept along by the main current: he is going to do fiscal stimulus and deregulation.

In a similar way, the markets have today latched on to the main fact about Theresa May’s speech: for all the knocking she has received in the press as indecisive and confused, she has a plan, which she has articulated reasonably clearly, and this plan is a viable starting point for negotiations with the EU.

Yes, commentators had already divined that the UK was heading for a ‘hard Brexit’, meaning leaving the Single Market — and yes, this is bad news for the economy.

But having the prime minister state it in black and white sweeps away a lot of uncertainty.

Risk of car crash Brexit ebbs

For the past six months, media have been full of speculation about whether the UK could retain single market privileges while restricting immigration from the EU and rejecting the European Court of Justice’s jurisdiction — two things May had decided Britain wanted, based on the referendum result.

The risk of the UK setting itself on a collision course with Europe on this issue has now been taken away. That debate is over. Britain has accepted that to regain control of its borders and escape the ECJ it will leave the Single Market.

Similarly, on the Customs Union, a big area of contention with the EU has been swept off the table. The UK will concede that it must leave the Customs Union if it wants to be able to conclude its own trade deals with third countries.

Starting from a low base outside the European Economic Area, it will try to negotiate trade access to the European market — what Deutsche Bank calls a ‘Canada-max’ deal.

These are bad outcomes for the UK economy, but only bad outcomes were available. What has become clear is that the UK’s negotiating position is clear and realistic, in that it is not diametrically opposed to the way the EU understands things, and has some chance of surviving the crucible of UK politics.

Rocks ahead

Many serious problems remain, including the €40bn to €60bn bill the EU side want the UK to pay for obligations it has taken on while an EU member; how to solve the problem of keeping the land border with Ireland open; how to placate a Scotland anxious to stay in the Single Market; and how much damage will be done to the City.

May cannot give the answers to these questions before the negotiations even begin. But she showed that she is aware of people’s sensitivities on these issues and wants to try and reach a solution.

Finally, with her Global Britain theme, May managed to set out a hopeful vision — convincing or otherwise — of how the UK can thrive outside the EU, by striving even harder than before to deepen its links with the rest of the world.

Britain has taken an immense gamble by deciding to leave the EU, which will be destabilising and is highly likely to be self-defeating.

But after six months of drifting, at least now there seems to be a hand on the tiller, and a course to steer.

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