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Deutsche Bank

Five potential Brexit scenarios and their impact on the pound

Sterling has seen increased volatility since the initial Brexit vote in 2016, and the trend looks set to continue even after three years of political wrangling

Deutsche Bank - Five potential Brexit scenarios and their impact on the pound

On Monday, a bill passed by the UK Parliament mandating that Prime Minister Boris Johnson seek an extension to the country’s current Brexit date of 31 October became law.

The legislation stipulates that if Johnson cannot produce a Brexit deal by the 19 October, the day after a crunch meeting with the European Council, he will be compelled to seek an extension of the UK’s exit date to 31 January 2020.

However, while the process seems simple on the face of it, there are a number of potential outcomes that could have radically different impacts on the British economy as well as on a key Brexit barometer, sterling.

Five possible routes

Speaking to BBC Radio 5 Live on Tuesday, Raphael Hogarth, an associate at think tank The Institute for Government (IfG), outlined five possible ways that the current Brexit impasse could play out.

The first scenario is that Boris Johnson follows the law and requests an extension of the UK’s Brexit date to 31 January, pushing the departure timetable into next year.

According to Jane Foley, head of FX strategy at Dutch financier Rabobank, such a move would likely cause forex markets to follow a similar pattern to when the UK’s exit date was extended from 29 March to 31 October by Theresa May’s government earlier this year.

Foley said there would likely be a fall in the pound’s volatility, however, the degree of recovery would be “relatively contained” as most of the potential upside had already been priced into the currency’s current value.

“There might be some additional gains”, Foley said, although it would be surprising if cable managed to move above US$1.24.

A second scenario would be that Johnson resigns as Prime Minister and is replaced by another politician, which Hogarth said was likely to be opposition leader Jeremy Corbyn, who would, in turn, seek a Brexit extension.

This would not require a general election as to become Prime Minister a Member of Parliament must simply be able to pass a confidence vote in the House of Commons (i.e secure the backing of a majority of MPs).

In this case, Foley said the character of the incoming government would the defining factor for currency traders.

If the new government was a “caretaker administration”, one that would be in place temporarily until a general election was called, the pound was unlikely to “react badly” due to the limited scope for Corbyn’s Labour to enact what Foley said were “Marxist issues that the markets were frightened of” in addition to the likely involvement of other parties such as the centre-left Liberal Democrats and the Scottish Nationalist Party (SNP).

The markets would also likely see this result as preferable to a Johnson alternative due to the explicit opposition to a no-deal Brexit among the opposition parties.

A full-blown Corbyn government may also be considered a ‘less bad’ option by many in the investment community, with both Citibank and Deutsche Bank both saying last week that a Labour administration would be preferable to a no-deal Brexit.

A third, if more extreme, option would be Johnson refusing to obey the extension law and pushing ahead with his existing plan to exit the EU with or without a deal on 31 October, an extreme and unprecedented move that analysts have already speculated could result in his arrest.

If such a strategy was undertaken, the pound could be headed below last week’s lows of around US$1.19, according to Foley, who added that cable could fall “much lower” if no legal repercussions arose and a no-deal exit seemed likely once again.

However, there is also be a chance that Johnson will return from the European Council summit on 18 October with a revised Brexit deal, which could then be approved by Parliament and keep the UK on track for an orderly exit by the end of the month.

While Foley deemed this as an unlikely scenario, such a resolution would be “celebrated” among the markets and business community as it would provide immediate clarification and an end to the uncertainty that has stymied decision-making across the UK economy, potentially sending sterling up to highs of around US$1.30.

“The fact that there was a deal would be met with such relief,” Foley said, adding that there was also likely to be “a very significant amount of inward investment” in the UK once clarity was achieved.

The fifth, and possibly even more unlikely scenario is that Parliament approves a no-deal exit from the EU at the end of October, which Foley said would only serve to exacerbate the uncertainty amid confusion over trading rules and the status of the UK’s future trade negotiations with other countries, resulting in a “very negative reaction” for the pound, which could potentially fall to below US$1.15 as a result.

External factors

While Brexit shenanigans have been one of the main driving forces behind the pound’s movements since 2016, global factors could yet influence sterling alongside any potential Brexit outcomes.

The ongoing US-China trade war could yet have implications for the UK’s export markets, while a fall in risk appetite had increased purchases of the US dollar, usually seen as a ‘safe’ asset in times of uncertainty, and pushed up its value relative to other currencies such as the pound.

Foley also says the trade dispute could keep the dollar at high levels even if the Federal Reserve decides to cut interest rates, which it is expected to do so “aggressively” in 2020.

However, for the foreseeable future, pound traders seem intent to keep Brexit in the crosshairs.

Quick facts: Deutsche Bank

Price: $8.07

Market: NYSE
Market Cap: $16.66 billion
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