- A no-deal Brexit is rising in likelihood as the UK’s March 2019 deadline approaches.
- No deal would be hugely disruptive for financial markets.
- It would likely send the British pound plummeting, UK stocks surging, and force the Bank of England into drastic action.
As the day of Brexit draws ever nearer, the prospect of Britain leaving the European Union without a deal continues to grow. What started out as an almost unimaginable scenario is now, in the minds of the British public at least, the most likely Brexit outcome.
Earlier this week, the government released a series of papers detailing what might happen in the event of no deal. They varied from shortages of medicines, to rising credit-card fees, to a shortage of sperm. What the government didn’t discuss is what might happen in financial markets if such a situation were to play out.
Thankfully, research house Pantheon Macroeconomics has modelled what no deal might mean for key British market assets in the aftermath of it happening next March. Although it would not be as seismic a shock as the initial vote to leave the European Union in June 2016, markets would see large moves across currencies, equities, and bonds.
More pain for the pound
First up, the British pound would inevitably suffer. Since the referendum, the pound’s movements have been almost entirely linked to Brexit developments. Any news that suggests Britain is heading for a softer Brexit, and it rises; any news to the contrary, and it falls.
That relationship is reflected in the pound’s recent slump to less than 1.28 against the dollar, which has coincided with the rising probability of no deal. If no deal does materialise, Samuel Tombs, Pantheon’s chief UK economist, says the pound would drop more than 10% from current levels in the immediate aftermath, falling to a low of $US1.15 by the end of March.
- SEE ALSO: There’s a counterintuitive argument that preparations for a nightmare Brexit will actually be good for the UK economy
Other analysts are inclined to agree with Tombs’ prognosis. Back in July, Neil Jones, Mizuho Bank’s head of hedge fund sales, told Bloomberg that in the event of a no deal Brexit, the pound would drop sharply and “hit new post-referendum lows.”
Commerzbank strategist Thu Lan Nguyen mirrored that viewing, saying she would “anticipate at least a reaction to the extent we saw after the referendum.” On the day after the referendum, the pound dropped more than 8%.
A rampant stock market
While the pound would plummet, the FTSE 100– which enjoys an inverse relationship with the currency – would likely surge to record highs.
A weak pound tends to mean a strong UK stock market. That is because it is heavily skewed towards companies that don’t actually make their money in the UK. The FTSE 100, for example, contains miners, oil firms, and pharmaceutical giants, with around two-thirds of all revenues for companies in the index derived from abroad. This has helped the index hit record high after record high following the vote.
Pantheon’s forecast is that the FTSE 100 breaks above 8,000 in the event of a no-deal Brexit, a rise of around 5.5% from Friday’s closing price.
Bond yields fall
Turning to the UK’s bond market, Pantheon forecasts the yield on the 2-year gilt would fall to 0%. It may seem counterintuitive that yields would fall, given that lower yields tend to reflect investors perceiving a bond as being safer – something unlikely in the event of a no-deal Brexit.
Pantheon’s argument, however, is that a no-deal Brexit would force the Bank of England to immediately reverse the normalisation of monetary policy it has embarked on in over last year.
The bank has raised interest rates twice since November 2017, hitting 0.75%, but would need to cut rates to 0%, as well as launch £100 billion ($US129 billion) of new quantitative easing, which in turn would suppress gilt yields, according to Tombs. That cut would be the first time the UK’s bank rate had dropped to 0%.
If these scenarios seem extreme, Tombs and his colleagues have some reassuring news, they put the prospect of a no-deal outcome at just 10%, citing their belief that Prime Minister Theresa May will capitulate to the EU’s demands, eventually leading to the softest possible Brexit.
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