Should investors fear a ‘hard’ Brexit?

Many investors would be concerned that Theresa May’s decision to resign as UK Prime Minister has increased the risk of a ‘hard Brexit’ that could damage the global economy.

But while that might cause short-term worries and volatility, we believe that a ‘soft’ Brexit scenario is still likely.

No deal Brexit

Theresa May has officially stepped down as Leader of the Conservative Party, triggering a contest to replace her. She will continue to perform her duties as PM until her successor is decided.

The polls indicate that former London Mayor, Boris Johnson, is leading the 10 candidates for the top job.

The market is now concerned the risk of a ‘hard’ Brexit – the UK leaving the EU with no formal agreement in place – has increased.

We believe the new Prime Minister is likely to take more of a hard Brexit stance compared to Theresa May who wanted to leave the EU with some sort of agreement in place.

Johnson himself supported Brexit and has flagged he would pursue a ‘no deal’ Brexit if he can’t renegotiate a better deal with the EU.

Economic damage

A hard Brexit or no-deal Brexit would have significant implications for the UK, EU and global economy and investors.

A hard Brexit would, in our view, mean a few things:

• It would potentially be disadvantageous for trade between the EU and UK. The UK and EU would have to trade under World Trade Organisation Rules. The UK would leave the single market and customers union and it would lose access to trade with its largest trading partner.
• It would probably lead the UK into a near-term recession. It’s predicated a hard Brexit could cut UK GDP by 3 to 4% over two years. 
• Over the long-run, it would likely lower UK potential GDP by around 1% because of slowing productivity and population growth.
• Those negatives could have flow-through effects to Europe at a time when the Eurozone economy is quite weak. A hard Brexit could shave around 0.5% to 1% off Euro growth over two years, according to the Bank of England¹
• The EU makes up around 21% of the world economy, so there may be a small, likely negative impact to world GDP.
• A hard Brexit may also be quite negative for the British pound.
  

So, we believe a hard Brexit is not a situation the market would want to see.

A soft Brexit could still have some short-term negative impacts on growth because of lost trade, but they would likely be relatively small.

A better deal

Given the significant economic fall-out from a hard Brexit, we think politicians in the UK don’t want that outcome, even though they might campaign to have a tougher stance on Brexit.

We think the new Prime Minister will be able to negotiate a better agreement for the UK to leave the EU, although it might take some time to get there.

And although the Brexit date is set for October 31, it’s still possible that date could be pushed back to later in the year.

So, while the risk of a hard Brexit has increased, a soft Brexit is still on the cards.

¹EU withdrawal scenarios and monetary and financial stability, Bank of England