Brexit risks have lessened, but the UK election is one for market watchers

By Diana Mousina
Economist - Investment Strategy & Dynamic Markets Sydney Australia

October 31 was supposed to be the UK’s “do or die” Brexit Day, but instead UK Prime Minister Boris Johnson has successfully called a general election in an attempt to break the Brexit impasse.

Ultimately, Johnson hopes a refreshed UK parliament will better progress a vote on the UK’s withdrawal agreement with the EU, or at least reach agreement on what Brexit will look like.

Just over a month away, on December 12, this election is worth keeping a close eye on. It is difficult to predict the outcome and its impact on Brexit – if the Brexit party get a larger share of the vote than anticipated, it may be harder for the Conservative party to leave the EU according to the terms agreed by Johnson.

It could mean the difference between a hard Brexit and a soft Brexit. In broad terms it’s the difference between a completely clean break, or the UK retaining regulatory features that are sympathetic to the bloc’s single market.

The impact of Brexit on global financial markets weighs heavily on this distinction.

Currently, around 50% of the UK’s imports are from the EU. If a hard Brexit takes place, the price of these imported goods would rise, the British economy would slow and financial markets would take a hit as consumers and businesses rein in spending1. EU trade uncertainty will also impact the 45% of British exports currently destined for the continent.

The biggest risk for the UK, the EU and global financial markets is if the UK leaves with no agreement in place. If this occurs, the UK will break all trade ties overnight and likely revert to World Trade Organisation rules while independent trade agreements are negotiated. This would be disastrous for trade in the short term.

The Bank of England has previously warned that a no deal Brexit could shrink the U.K. economy by 5.5% in a year2, while British and European stock markets will certainly be punished, as will the U.K. currency3. Additionally, the International Monetary Fund became the latest to warn that a no deal risks triggering a further slowdown in global growth.

However, preparations and contingency plans from governments and companies are helping to mitigate the risks4. In particular, Johnson has been focused on trade in the Brexit transition period.
Johnson’s current Brexit deal allows the UK to take back control of its laws, trade and money, whilst setting terms for the trade relationship between the UK and the EU during the transition period.

Meanwhile, the US is adding pressure as it seeks its own trade deal with the UK, with US President Donald Trump claiming that Johnson’s Brexit deal could prevent a trade deal with the US, although this is disputed by the British government.5

The upcoming election will very much centre around Brexit EU trade agreements. As the biggest election issue, UK voters will indicate whether they support Johnson’s transition period agreement, or support the Labour party’s Brexit approach (which will likely result in a new referendum on Brexit should Labour be elected). The recent surge in the polls for the pro-remain Liberal Democrats will further complicate the matter, as will the likely continued dominance of the Scottish National Party in that country, who will pressure a new government for a second independence referendum.

The fact remains, however, that all major parties will enter the election supporting a soft Brexit or none at all, so the risks of a hard Brexit, especially with no transition agreement, appear to have diminished somewhat in recent months. Nonetheless, markets will be watching closely on December 12.

 

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Diana Mousina, Senior Economist
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While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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