US based currency expert, Greg Gibbs breaks down the rules of Brexit gamesmanship and what it means for the future of the British pound
Unless you have been living under a rock, you will have heard a lot of Brexit noise lately. This has caused a fair bit of angst for traders of the Great British Pound (GBP), but has not driven as much volatility as you might expect given the breathless waves of opinion resounding in the press.
On Friday the 6 July, UK Prime Minister Theresa May announced her cabinet, congregated at her country residence of Chequers, had agreed on a long awaited plan to negotiate with the EU on trade. The plan was applauded and received with relief by UK industry leaders, offering up what has been widely described as a ‘soft Brexit’. Unfortunately, as it turned out in the following week, it was called a lot worse by the ‘Eurosceptics’ or ‘Brexiteers’ in May’s own Tory party.
The GBP rose in what was left of the day and further Monday morning in Asia, to its highest, 1.3360 against the USD, since mid June. There was much promise for the pound in the Chequers plan, now detailed in a 'white paper'.
The wheels were turning - cabinet had agreed on a plan, the UK economy was bouncing back from a soft first quarter, the Bank of England had set sights on hiking rates for a second time on the 2 August, and England was lining up for its first World Cup title since 1966. It was ‘game-on’ for the pound, as far as I was concerned.
The key to the UK economy and the GBP in the Chequers plan was that it sets out to retain free trade in goods between the UK and the EU. One clear political benefit is that it would avoid border control in Ireland, a red-line for PM May. Companies, such as Airbus, felt the deal might bring continuity for business, lessen the desire to relocate UK operations to the EU, and potentially boost confidence and investment in the UK impacted in the last two years by Brexit uncertainty.
Chequers plan has flaws
Of course, this is not a perfect fix for the Brits, having shot themselves in the foot by voting pro Brexit on 23 June 2016. For one, the plan would leave services out of the EU single market; 80% of the UK economy. The UK has a large trade surplus in services with the EU, helping balance its even larger goods deficit. And, it would tie one hand behind the UK government's back in trade negotiations with other parts of the world. Nevertheless, it might allow the UK economy to walk with a limp rather than stumble on for years.
Euphoria for the GBP was also short-lived. It fell back when, first, Brexit Secretary David Davis, and then Foreign Secretary Boris Johnson, resigned last Monday, laying to waste any sense of unity in the Tory cabinet. Not to mention, generating significant speculation that PM May will face a leadership challenge before long.
The Tory party remains split over Brexit. And the number one sniper after PM May’s job, Boris Johnson, is now on the back benches free to take pot shots in her direction.
The major bone of contention over the Chequers plan is that it offers to align swathes of UK law with the EU in exchange for free trade on goods. Now, there has been much virtual ink spilt over the pros and cons of the Chequers plan but I have not been allotted enough column inches to digress the subtleties of this raging debate. Though there is one; a major criticism of the Brexiteers, threatening to burn down the government, is that they have no viable alternative.
What’s the alternative?
There is no alternative to the Chequers plan that has a hope in Hades of getting through negotiations with the EU that has made it very clear from the start that there will be no cherry-picking from the 'four freedoms' of its single market; free movement of goods, capital, services and people.
The Brexiteers only alternative, especially at this late stage of the game, is crashing out of the EU with no deal on trade. Most observers see this as a recipe for economic chaos. Probably a deep and prolonged recession in the UK and a growth wobble in the EU. Not a good scenario for the GBP.
As such, some commentators are calling for GBP to collapse back into the 1.20s; repeating the lows observed in the early days of Brexit in 2016. You may wonder then, why is GBP largely stable in the last week, albeit down from its Monday morning Chequers high?
The answer may lie in a little bit of gamesmanship. The Brexiteers are solid in number, sufficient perhaps to bring a vote of no-confidence against PM May and vote down any Chequers inspired deal struck with the EU. However, the ‘Europhiles’ and moderates in the May government are larger in number and will probably back May in a vote of no confidence. If the Brexiteers vote down Brexit legislation, they will force May to call a new election that will be like a new referendum on Brexit. The Labour Party would probably win the election and might opt not to Brexit at all or pursue an even softer Brexit than found in the Chequers plan.
When we look at the probability distribution on Brexit, a Chequers like soft Brexit sits in the middle as the most likely outcome, with a very fat no Brexit tail cheered on by UK business and the GBP. The tail on the hard Brexit, crashing out of the EU with no trade deal, is unlikely to happen.
It is also possible that the anger and egos of the Brexiteer camp could lead to a leadership coup, potentially generating some knee-jerk selling of the GBP. However, this may be limited and short lived as the market contemplates the increasing probability that Brexit does not happen at all.
By last Friday, the GBP was finding its feet again as PM May had seen off US President Trump’s incendiary Sun News interview. She stood composed beside him in a joint press conference as Trump back-pedalled and heaped praise on May, conceding the extreme challenges of negotiating a satisfactory Brexit outcome.
As I wrote for the Wire in 22 May 2018, ‘GBP clawing back from Brexit fall, AUD adrift’, May has survived frequent lashings in the press and low public approval, while moving the process forward. Perhaps there is a begrudging recognition that few others have the will or resolve to strike a workable deal with the EU? Nevertheless she remains on a tightrope. And the longer she does, the more capable she appears to be, even if the winds are swirling as she approaches the other side.
GBP is a bit binary, a Chequers deal or a no Brexit gets a 10% or more rally in GBP. Ongoing turmoil keeps GBP near 1.30 against USD. A hard Brexit gives 1.20. AUD probably steady against USD to lower 0.70 to 0.75 range.
It could be several months before we are any the wiser on an EU/UK deal. So it doesn’t seem like it will move too much for some time. The GBP may be choppy at times.
I think a soft Brexit is the most likely outcome, so I’d suggest GBP/AUD 10% higher in 12 months.
Greg Gibbs is the founder and director of Amplifying Global FX Capital and has long standing expertise in foreign exchange and currencies.