//Don’t give up on Britain yet — the odds of ‘hard Brexit’ just shrank

Don’t give up on Britain yet — the odds of ‘hard Brexit’ just shrank

British Prime Minister Theresa May has offered lawmakers a vote that would prevent the United Kingdom from tumbling into a disruptive “hard Brexit” and instead delay its exit from the European Union.

As the likelihood of an orderly departure from the EU strengthens so too does the argument for investors to avoid pulling out of the beleaguered U.K. market — at least for now, according to some analysts.

“If anything at the moment, pulling out of the U.K. is the worst thing you could do because the market has gotten down on the U.K.,” Peter Westaway, chief economist at Vanguard.

All the doom and gloom in the market is probably a little misplaced

Peter Westaway, chief economist at Vanguard

Placing the probability of a “no-deal Brexit” at just 5 per cent, Westaway argued “there are enough sensible heads around the table” to prevent that outcome.

“All the doom and gloom in the market is probably a little misplaced,” he told reporters.

The British pound surged Tuesday as May promised members of parliament three crucial votes. The first will decide whether the U.K. will leave the EU on March 29 under the terms of her deal — an arrangement that has so far failed to win the support of lawmakers. The second vote will decide whether to leave with no deal — a so called hard or “crash” Brexit. Should that option be rejected, a third vote will determine whether to ask the EU for a delay in departure by up to three months.

The vote on May’s deal would occur by March 12 with the additional votes occurring in the following days.

“I don’t want to see an extension,” May said, adding that any delay to Brexit should be “as short as possible.”

A hard Brexit would shave up to 2 per cent off the U.K.’s gross domestic product in 2019 and prompt a drop in the sterling, said Jeremy Stretch, head of G10 FX strategy at CIBC Capital Markets in London. But the likelihood of that happening is now far more remote at about 10 to 15 per cent, he said.

“A delay looks inevitable, the PM has flagged that up as a realistic probability today,” said Stretch. “So we’re still looking for a scenario that in the next four months or by the end of June we will see some sort of managed solution. Overall I think over the next 6 to 12 month time horizon we will see sterling appreciating and recovering more of its lost value subsequent to the referendum in 2016.”

But at the moment, the ongoing political turmoil in the U.K. has made sterling assets “less manageable to trade,” leading many investors to sit on the sidelines, he added. That risk will continue.

“You’re reliant on politicians who are sometimes making comments meant for the domestic audience or even their own party not financial markets, but of course financial markets read them and respond accordingly,” he said. “That’s partly why many people have been sitting outside sterling assets, the degree of political risk is high.”

Brexit uncertainty has already taken a toll on the British economy. Though the U.K. was the top performing economy in the G7 group of nations prior to the referendum in 2016, it has since slipped to the bottom of the pack, Westaway noted.  And business uncertainty has also prompted many firms to shift operations abroad or postpone investments.

At least some of that damage could be permanent, said Carsten Brzeski, chief economist at ING Germany in Frankfurt.

We are seeing more and more companies leave the U.K. everyday

Carsten Brzeski, chief economist at ING Germany

“Even if we get a delay, or a second referendum, and it turns out the U.K. remains, will those companies reverse their plans? I doubt it,” he said. “If another referendum were in favour of remain, it still looks like it would not be by a huge margin. In two to three years, a new British government could then pick up the Brexit argument again. It’s too much uncertainty for businesses.”

Brexit is expected to hurt the European Union too, shaving its growth potential at a time when its economy is already slowing and facing the threat of potential auto tariffs from the United States. A soft or orderly Brexit is expected to shave 0.2 per cent of European GDP growth, Brzeski said, with smaller, more trade dependent countries like Belgium and the Netherlands suffering more than others.

But ultimately, the EU would benefit from the shift in jobs and business spending away from the U.K. and toward Europe, Brzeski says.

“We are seeing more and more companies leave the U.K. everyday,” he said. “This is a structural negative impact on the U.K. economy but for the European economy it means more jobs leaving the U.K. coming to continental Europe, increasing purchasing power. This means that for the EU as a whole it would be net positive.”

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