Main takeaways
As the Brexit end-game has started, this report gives an update to the Brexit negotiations, the possible outcomes, what the obstacles are and what we expect of the economy and GBP.
In our view, the most likely outcome is a 'decent Brexit', which is soft in the sense that the UK stays close to the EU but hard in the sense that the UK is leaving the single market. The Irish border remains the most difficult issue.
The likelihood of a 'no-deal' Brexit has increased. While there are most likely enough hard Brexiteers to trigger a leadership contest, it is more difficult for them to win it.
The deal is likely to include a legally binding withdrawal agreement and a political declaration on what the future relationship beyond the transition period should look like.
The real test for Prime Minister Theresa May is when the withdrawal deal is put forward for a vote in the House of Commons, as there are enough hardliners to vote it down, unless PM Theresa May persuades Labour MPs to vote in favour. We expect Theresa May to be able to get some Labour support, as her deal is better than the alternative (no deal) and the rationale would be that Labour could try to soften Brexit at a later point.
The likelihood of a general election or a second referendum before 29 March is low. A soft Brexit keeping the UK in the single market also seems unlikely.
While growth is still slower than before the referendum, it is still above trend and the unemployment rate is on a falling trend.
The Bank of England seems to have launched a 'once-a-year hiking cycle' and we do not expect the next hike to arrive before May 2019, depending on the outcome of the Brexit negotiations.
Brexit remains the key driver for the GBP and uncertainty related to the outcome is likely to keep the GBP volatile and undervalued in the coming months. We expect EUR/GBP to break substantially lower when markets can start to price out a 'no-deal' Brexit risk premium. We forecast 0.84 in 6M and 0.83 in 12M.
In case of a 'no-deal' Brexit, we expect EUR/GBP to spike higher and a test of 1.00 should not be ruled out.
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