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Home » Insights » Investment Management » A Big Week for Brexit

A Big Week for Brexit

Stan Poltavets | Investment Management | September 6, 2019 (May 17, 2021)

It’s a drama worthy of Shakespeare. Boris Johnson, UK Prime Minister and Conservative Party leader, has for a while claimed he would make sure the UK exits the European Union (EU) – deal or no-deal – by Oct. 31, 2019. Increasing the likelihood of a no-deal Brexit, and thus perhaps scaring the EU into a deal, Johnson last week suspended Parliament until October 14. The markets were not pleased, since most analysts think a no-deal Brexit could tip the UK toward recession.

But then this week, Parliament (including Boris’ brother Jo) sprang into action. Lawmakers voted (328 to 301) to introduce a bill that would delay Brexit, and Johnson’s Conservative Party lost majority (see chart below). Just as important, lawmakers voted 327 to 299 to enact the proposed bill, which requires the UK to seek a three-month extension to the Brexit deadline if the UK can’t reach an agreement with the EU by Oct. 19, 2019. This would effectively move Brexit to January 2020. Johnson responded by calling for a snap election, but he failed to get two-thirds of the vote required for that (298 voted for an election and 56 against).

Seats by Party in UK Parliament

The Meaning of Soft Vs. Hard Brexit
The divorce decree between the UK and the Eurozone can take one of two major forms, known as soft Brexit (deal with the EU) and hard Brexit (no deal). The two paths hold very different implications for the UK, the EU, and the rest of the world.

In a soft Brexit, the UK would remain bound by EU regulations. Supporters of soft Brexit believe this minimizes disruption to trade and business overall, while also reducing costs associated with leaving the EU. The UK would stay in the EU’s single market system and/or customs union, and it would accept EU’s rules and tariffs, even though it would lose all voting rights for/against regulations. However, it would then be difficult for the UK to enter into trade deals with other countries.

Variations of soft Brexit have been proposed, whereby the UK leaves the EU but stays in the either the EU customs union or the EU single market. Single market means all rules that govern economies are the same, from regulations on food safety to the free movement of labor. In customs union, there are no taxes or customs clearance on goods traded among member countries. But if the UK stays in the customs union or the single market, this leaves the opposition asking: Why leave the EU at all?

A hard Brexit rejects the idea of close alignment with the EU. The goal, for those who support it, is to escape EU regulations. UK would be leaving both the single market system and the customs union of the EU and would be required to strike free-trade deals and customs agreements with the Eurozone and the rest of the world.

The conflict between a soft versus a hard Brexit comes to a head around the shared border between Northern Ireland (which is part of the UK) and the Irish Republic to the south (which will stay in the EU). The EU insists that post-Brexit, no goods can enter into the EU via Northern Ireland that do not meet its rigorous regulatory standards. This creates a problem for the Irish Republic to the south: either it reinstates the border with Northern Ireland, or it runs the risk of being kicked out the EU’s single market. UK and Ireland, however, have agreed to keep the border open so that people and goods are free to cross back and forth.

United Kingdom GDP
British Pound vs US Dollar Exchange

The Downside of a No-Deal Scenario
Bloomberg economists estimate that if a no-deal Brexit occurs, UK economic growth would probably slow sharply on a quarterly basis, approaching recession soon after departure. The severity of the slowdown will depend on the willingness of both sides to keep goods flowing between the UK and the rest of Europe. The Bank of England will likely be forced to cut interest rates to support the economy, despite inflation potentially surging as a result of tariffs and a likely fall in the British pound. The combination of lower trade flows, less migration and weaker investment will almost certainly hinder the UK economy’s potential growth rate. Given a no-deal Brexit, it’s estimated the UK economy would be 2.5% smaller by 2023 compared to where it would have been had it stayed in the EU.

However, the no-deal scenario is losing ground due to Boris Johnson’s loss of majority, the passing of a bill to delay Brexit, and his loss at a bid to call an election. This resulting reduction in risk can be seen in the recent uptick in the British pound vs. the US dollar.

LNWM Exposure
Because we invest globally, across regions and markets, we have exposure to both the UK and the EU. Hence, we are keenly focused on the implications of Brexit. An attribution analysis of our international asset managers indicates they have done a good job navigating the implications of Brexit, having benefitted from security selection within the Eurozone and the UK. However, we are not immune from the impacts of Brexit and continue to evaluate progress, which includes ongoing dialogue with our asset managers. We remain comfortable with our current exposure to both the UK and Eurozone.

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Stan Poltavets

Stan, an investment associate at Laird Norton Wealth Management, specializes in ESG strategies and sustainable investing. He enjoys researching new ways that clients can invest in line with their values.

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