Brexit and Sterling Volatility

Sterling was under pressure this morning as the probability of a ‘hard Brexit’ scenario rose following the resignations of several ministers in Theresa May’s cabinet in protest to her draft Brexit deal.

Sterling sank by over 1.5%* versus the US Dollar and the Euro having traded flat yesterday, while bank stocks suffered heavily (down 5-7%*) and gilts rallied with the yield on the 10 year gilt falling by over 14 basis points*.

The Sterling/ Dollar exchange rate is currently at $1.279, though still above the recent lows of $1.27 observed in August and October.

After May presented the draft Brexit deal and announced cabinet support for it late last night, markets were perhaps caught by surprise this morning as several ministers resigned. In particular the resignation of Secretary of State for Exiting the EU, Dominic Raab, shocked markets given his proximity to the negotiations. Other resignations followed, including Esther McVey, Work and Pensions Secretary, and a number of junior ministers.

The draft deal text focuses on three areas:

However, once again it was the Irish border question which has caused the most difficulties. Objections to the deal focused on the Northern Irish ‘backstop’ which the EU has insisted on including in the draft treaty. This backstop seeks to avoid a hard border with Ireland by keeping Northern Ireland aligned with certain EU rules and standards in case of no suitable final deal. This is clearly unpalatable to several cabinet ministers and in particular the Brexiteers among the Conservative party.

Both Labour leader Jeremy Corbyn and shadow Brexit secretary Sir Keir Starmer have since stated that this draft deal does not meet Labour’s six tests for a good deal, and therefore Labour would vote down the deal in parliament. In addition, the Northern Irish DUP party, whose 10 MPs contribute to Theresa May’s slim majority in government, have strong reservations about being subject to EU rules without any say on them in the case of the backstop being enacted, which would also risk a de facto customs border down the Irish Sea.

What’s next?

Markets are focusing on the chances of May getting this deal through parliament, which seems to have diminished following today’s resignations and objections from Labour, Conservative Brexiteers and the DUP. Hence, the risk of a hard Brexit appears to have increased, and this has led to the market weakness today. The possibility of a leadership challenge against May can also not be ruled out, although it is expected she would survive any challenge. May’s parliamentary majority is slim – the Conservatives have 315 MPs plus 9 voting DUP MPs, versus 321 needed for a majority. Hence May needs to convince Conservative hard-line Brexiteers (whose numbers are estimated at 20-40) and the DUP to back her deal. If this is not possible, May is reliant on support from Labour MPs to pass the deal through, made all the more difficult as Corbyn and many in the Labour party sense the opportunity to push for an election and seize power. This event would also be perceived extremely negatively by the markets. Finally, a number of pro-remain MPs will see this as their chance to call for another referendum on Brexit. Given lack of support for this solution from both Corbyn and May, it would require a cross-party alliance of MPs voting against their leadership, which is a difficult scenario to imagine.

Overall, we can certainly expect more volatility in the price of Sterling and perhaps a few more resignations before we have any further clarity.

Our belief is that enough Conservatives will back May’s deal for fear of a no deal or a Corbyn government. However, the chances of this occurring are certainly slimmer and warrant taking a cautious stance in current markets.

Robert Van Kleeck
Senior Fund Manager

* Source Bloomberg

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