Sterling singing to (leaked) tune ahead of Theresa May speech

Reports in the British press about the content of Theresa May’s planned speech tomorrow seem to confirm that the prime minister may sacrifice access to the Single Market in exchange for control over EU immigration into the UK.

Unsurprisingly perhaps, Sterling has weakened further but the currency may get some (temporary) respite if the content of Theresa May’s actual speech is somewhat more conciliatory.

In particular I would expect markets to focus on whether the UK government has moved closer to agreeing to a transitional arrangement once the UK has actually left the EU and whether any progress has been made in protecting the all-important UK services sector.

About 45% of the UK’s total exports are destined to the other 27 EU member states and about 53% of its total imports come from the EU. In comparison, only about 9% of the EU-27 exports of goods and services are destined for the UK. Similarly, only 9% of the EU-27 imports of goods and services come from the UK.

The EU thus has far more leverage over the UK than vice-versa assuming these 27 EU member states are willing and able to negotiate as one trading block, in my view. This imbalance is even greater in traded goods alone.

However, when it comes to services, the picture is somewhat more balanced and the UK may arguably have a stronger bargaining hand.

Simply put the EU buys and sells a far greater share of its services to/from the UK than it does for goods and it may be difficult for EU countries to substitute imports of financial services from the UK given London’s pre-eminence as a financial centre.

Read Sterling singing to (leaked) tune ahead of Theresa May speech in full.

UK inching towards Brexit

British Prime Minister Theresa May will make a speech on Tuesday 17th January in which she will set out in greater details her plans for the UK’s exit from the EU.

There have been few signs that she is willing to tone down her mantra of the UK regaining control over immigration in exchange for a bespoke trading deal with the EU which may exclude access to the Single Market.

If Theresa May sticks to her guns next week I would expect Sterling to weaken further.

A sell-off in Sterling could be partly curbed if Prime Minister May agrees more explicitly to a transition agreement whereby the UK still retains some of the benefits of EU membership even after the UK has officially left the EU.

If MPs perceive Theresa May’s speech as insufficiently detailed or it is not backed up with a detailed and formal government white paper, parliament may decide to delay or even scupper the process by which Article 50 is triggered.

This would at the margin increase the perceived odds of the UK remaining in the EU and may provide some relief for Sterling.

However, I would view this as only a temporary reprieve as ultimately the government has a popular mandate for the UK to leave the EU.

The apparent resilience of British economic growth since the June referendum has given weight to the arguments that the economy can easily weather the UK’s exit from the EU and that the British government is in a strong negotiating position.

However, the risk now is perhaps that too much confidence is being placed in the British economy’s ability to weather a number of possible forthcoming challenges.

Read the full article: UK inching towards Brexit

The A-Team had a plan, the British government has a nebulous goal

The UK has its own eclectic A-Team led by Prime Minister May, tasked with getting the UK out of the EU and securing a more beneficial relationship with trading partners.

Theresa May, David Davis, Liam Fox and Boris Johnson have been dealt a tough hand and unsurprisingly have so far refused to reveal the intricate details of their daring plan.

But voters, businesses, parliament, EU leaders and foreign trading partners are pressing the government to elaborate on its tactics and strategies for Brexit.

There was break-through of sorts on 7th December, with the 650 members of the House of Commons (MPs) voting overwhelmingly to allow the government to trigger Article 50 by end-March in exchange for publishing the details of its Brexit plan.

But the devil is in the detail – or lack thereof. This parliamentary vote is not binding and the government has only agreed in the vaguest of terms to publish its plan for Brexit.

If MPs receive the plan late in the game and/or it is insufficiently detailed and assuming the Supreme Court rules that government has no prerogative to trigger Article 50, parliament may decide to delay or even scupper the process by which Article 50 is triggered.

Moreover, this likely vote in the House of Commons and House of Lords may well be only one of multiple votes which parliament has to hold between now and the approval of a final treaty between the UK and the EU.

In addition to these possible parliamentary hurdles, the government may also have to navigate a number of pending legal cases.

Some of these parliamentary votes may not take place and these legal actions may fail. There is certainly scope for further compromise between Theresa May’s government and parliament.

But the risk is that this reputation-sapping cat-and-mouse game extends beyond March, in turn making it far more difficult to predict the end-outcome – which ranges from the UK reverting to WTO rules (the “hardest” form of Brexit) to the UK staying in the EU.

Given the uncertain path which British executive and legislative bodies will take to reach a difficult-to-predict outcome at an unidentifiable point in the future, forecasting Sterling remains fraught with difficulty.

In this context I would expect Sterling to continue lacking direction near-term, particularly as the FX market has, it would seem, already priced out the more negative scenarios for the UK economy. Mixed UK data may not provide Sterling with much direction either way.

Read the full article on my website: The A-Team had a plan, the British government has a nebulous goal

UK economy post referendum – for richer, but mostly for poorer

We may well never know the true extent of the impact of the EU referendum outcome on the British economy, markets and ultimately standards of living. This may not be the most satisfying conclusion, but this uncertainty is one which policy-makers will have to grapple with.

As to the bigger question of whether the UK is better off today or will be better off in years to come when one takes into account not only the impact on the economy but also broader, less tangible issues such as sovereignty, the answer is and will likely remain even more subjective.

In any case, available data paint a patchy picture of the UK economy post-referendum. Construction and services have been harder hit than manufacturing. Retail sales were strong in July thanks in part to a robust labour market and plentiful lending. While this defies the collapse in consumer confidence temporary factors may also have been at play.

The residential property market at a national level has been softer but resilient post referendum. Mortgage lending remains depressed but government policies are for now more likely to blame. The commercial property market has been harder hit.

Sterling’s 10% collapse since the referendum, following a 10% depreciation between November and June, is seemingly supporting economic growth and demand for UK assets even if history suggests that it is no panacea. Its inflationary impact has so far been very modest but the risk is a squeeze on profit margins and real wages.

At the same time sterling’s collapse has tangibly eroded the UK’s net wealth, at least when expressed in foreign-currency terms – a fact largely ignored by policy-makers and the media.
I would expect the BoE to continue favouring monetary and credit policies which explicitly help spur lending, spending and investment and, implicitly at least, help cap sterling. While this may not translate into another policy rate cut or round of QE near-term, the BoE is likely to keep this option firmly on the table if the UK economy fails to return to trend in the next six months.

To read my further thoughts on the UK Economy after the Brexit vote, read the full article on my website.

Post Referendum Circular Reference

It has been a fortnight since the UK electorate voted to leave the EU and the British political and financial landscape has already changed dramatically. But what we don’t know or can only tentatively forecast still dwarfs what we know.

The referendum result simply reflected a popular preference for the UK to leave an international organisation, nothing less, nothing more. There is no precedent for UK and EU leaders to rely on and Article 50 is at best only a very skinny rule book.

For all intents and purposes UK and EU leaders are flying blind. It’s not even obvious who is at the controls, let alone who will lead negotiations on behalf of the EU and in particular the UK following seismic changes in political personnel.

The next steps are thus anything but straightforward and the UK government and EU are currently caught in a prisoner’s dilemma, with none of the key players seemingly willing to make the first move.

The referendum result is not legally-binding, only advisory, and therefore the Lower House of Parliament will likely have to vote on whether to trigger Article 50. But the British government has so far provided only a vague wishlist and simply doesn’t know what the EU may or may not agree to.

Parliament will not want to kick start an almost irreversible process whereby the UK has announced a divorce but doesn’t know the terms and conditions of this divorce, let alone what its new relationship will look like. Unsurprisingly, the British government is playing for time.

But EU leaders have suggested that discussions about the UK’s exit from the EU and future trade agreements were conditional on the UK government first triggering Article 50. And that takes us back to square one.

When this deadlock is broken will depend on many variables, including the length of the stalemate itself, who is in charge at the point of making a decision and the ability and willingness of negotiating parties with different vested interests to compromise.

I would argue that the longer this stalemate lasts, the greater the likely damage to the UK and EU economies and the greater the odds that Article 50 is not triggered in the first place or that a mutually satisfactory deal is eventually reached. Early British general elections cannot be discounted, nor can a second referendum in a more extreme scenario.

Assuming that the current circular reference paralysing EU and UK leaders is unbroken near-term, the associated uncertainty will likely continue to weigh on the UK economy, sterling and global risk appetite. Whether this morphs into a deeper and more widespread crisis may boil down to how patient global financial markets are willing to be.

Political, financial and economic upheaval…and now for the hard part.

Brexit: More questions than answers

The UK, the world and financial markets have now had five days to digest the British electorate’s vote to leave the EU and its impact on UK and global asset prices.

So far Sterling and Japanese and European equity markets have borne the brunt of the initial shock, while the FTSE is down only 3.3% since Thursday and most major and emerging market currencies have been reasonably well behaved (see Figure 1).

But there are still far many more questions than answers and the situation remains extremely fluid.

For starters there is no precedent for a country leaving the EU and thus no clear-cut rulebook to rely on. The government has limited institutional capacity to start negotiations with the UK’s 27 EU partners until Article 50 of the Lisbon Treaty is triggered and no timeline has been provided for when this will happen (assuming it is triggered at all).

Perhaps unsurprisingly given the mammoth task ahead, the Leave campaign leaders have been very short on specifics regarding the mechanics and timing of the UK’s exit from the EU, the likely shape of future trade treaties and national policies such as immigration. Prime Minister Cameron’s de-facto resignation and wholesale changes in personnel in the opposition Labour Party are adding to the head-scratching.

Moreover, it is not one country seeking to leave the EU, but a union of four countries – England, Wales, Scotland and Northern Ireland – which further complicates matters as both Scotland and Northern Ireland seem intent on remaining part of the EU and potentially breaking free from the UK.

At this point in time, all we can do is take stock of what we know (or at least we think we know) and what we don’t know (but can tentatively try to forecast).

I would conclude, as I did in Europe – the Final Countdown (21 June 2016), that the many layers of political, legal, economic and financial uncertainty are likely to keep UK investment, consumption and employment, as well as Sterling on the back-foot for months to come. Financial market volatility is also likely to remain elevated in coming weeks.

In this context the US Federal Reserve is likely to keep rates on hold in coming months and the European Central Bank can probably afford to do little for the time being. The Bank of England is likely to seriously contemplate cutting its policy rate while the Bank of Japan will be under renewed pressure to curb soaring Yen strength.

Of course, British policy-makers and business associations have come out and said the right things in order to limit the carnage and contagion. But they have far more limited room to reflate the economy and fade gyrations in financial markets than they did during the 2008-2009 great financial crisis. They are not in control at this juncture and it is not obvious who is.

Read the full article on my website, here is discuss the knowns, unknowns and potential ramifications of the UK voting for Brexit.