The first part of Prime Minister Boris Johnson’s Withdrawal Agreement (WA) defines the legally binding terms of the UK’s exit from the EU: leave the bloc on Jan. 31, 2020, with a one-year transition period which maintains the status quo. The two sides could agree to a one-off extension lasting two years if requested before July 1, 2020.
The second, non-legally binding part, suggests what the trading relationship could look like beyond Dec. 2020: a very loose free trade agreement (FTA) that includes limited regulatory harmonization and zero tariffs on goods (the deal does not cover services).
The government aims to finalize the FTA quickly and to start trading under these new terms from Jan. 2021. If the FTA is not in place by then, trade would commence under WTO rules. The estimated impact of Johnson’s deal on the economy varies.
Long-term impact of various Brexit outcomes on UK GDP
Johnson's Withdrawal Agreement is a harder form of Brexit than Theresa May’s
|Johnson's Withdrawal Agreement||May's Withdrawal Agreement||Hard Brexit (WTO terms)|
|London School of Economics||-6.4%||-4.9%||-8.2%|
|UK in a Changing Europe||-5.8 to -7.0%||-5.5%||-8.7%|
Source - National research correspondent
General election scenarios
The outcome of the general election may yet alter Brexit's course. Given current polls, we see three viable scenarios: a Conservative majority, a Conservative-led minority, or a Labour-led minority.
Conservative majority government
If the Conservatives maintain their current 10 percent lead in the polls they would likely win a majority in the House of Commons. Brexit Party leader Nigel Farage agreeing not to field candidates in constituencies won by the Conservatives in 2017 could help them retain seats. But Farage’s help comes at a price: assurances an extension to the transition period beyond 2020 will not be sought.
With a Conservative majority, we would expect the WA to pass swiftly, perhaps in time for the UK to exit the EU on Jan. 31, 2020 in an orderly fashion (with a one-year transition period). We would expect the pound to initially react positively to this, as it would give clarity to an immediate exit. Gains may be limited given the currency’s recent rally and attention soon turning to the extension request and life after the transition period.
If an amendment were to pass eliminating a transition, or if the government were to decline to request an extension, it would be crucial to finalize the FTA with the EU before the end of 2020, a colossal task, to avoid trading on WTO terms (i.e., a no-deal Brexit) from 2021.
Conservative minority government (hung Parliament)
But if the Conservatives are unable to win a majority, more Brexit gridlock is likely.
We would expect more attempts at amending the WA, with a view to effect a softer Brexit (including a longer transition period, Parliament’s involvement in an extension request, or more regulatory harmonization). A second referendum would be seen as another way to break the impasse, and would be possible. The pound would probably fall in the near term given this uncertainty and investors adopting a wait-and-see attitude.
Labour minority government
We would expect the Scottish National Party (SNP) and the Liberal Democrats to enter into “confidence and supply” arrangements with the Labour Party. These are more flexible than coalitions, allowing votes against the government on certain issues.
Labour has stated it would seek to renegotiate the WA to soften it, and then put it to a referendum. The price for the SNP’s support would likely be a second referendum on Scottish independence.
Although sterling could rise in the short term on hopes of a second Brexit referendum or softer exit from the EU, the move could be short-lived as the complexities of reshaping Brexit and fears of Labour’s left-wing policies weigh on the outlook. We note that in a minority government, Labour’s most extreme policies are unlikely to be enacted.
Bank of England: It depends …
The Bank of England (BoE) recently struck a dovish tone and lowered its growth and inflation forecasts. Future moves clearly depend on how the election plays out. Under a majority Conservative government endorsing a quick Brexit, the BoE may stay on hold as long as the economy does not weaken further. It could readopt a tightening bias if large fiscal stimulus fosters inflationary pressures and the economy proves resilient. In the case of a hung Parliament or Labour minority government and more Brexit delays, with uncertainty remaining entrenched, a rate cut would be more likely.
We remain Market Weight on UK equities as valuations appear attractive. We recently changed our bias from internationally focused companies to a more balanced approach between those and domestic-centric firms. We like banks and consumer stocks in particular. Investors will need to continue to be nimble.
We are Market Weight on UK Gilts, reflecting the BoE’s dovish tone, and on sterling-denominated investment-grade corporate bonds, which offer attractive yield pickup, though investors should continue to be selective.
Non-U.S. Analyst Disclosure: Frédérique Carrier, an employee of RBC Wealth Management USA’s foreign affiliate RBC Europe Limited contributed to the preparation of this publication. This individual is not registered with or qualified as a research analyst with the U.S. Financial Industry Regulatory Authority (“FINRA”) and, since she is not an associated person of RBC Wealth Management, she may not be subject to FINRA Rule 2241 governing communications with subject companies, the making of public appearances, and the trading of securities in accounts held by research analysts.