Brexit becomes a test of patience

The British parliament votes against the Brexit contract negotiated by May and even the announced "Plan B" brings no new ideas. However, the capital markets are reacting calmly. A last-minute agreement remains the most likely scenario.

Parliament rejects the negotiated Brexit agreement

Last Tuesday, a clear majority in the House of Commons voted against the withdrawal agreement negotiated by Prime Minister Theresa May with the EU. Among May’s party members, the MPs loyal to her voted for the deal, while the Brexiteers and the opposition resoundingly rejected it. There were 432 votes against and only 202 in favour of the agreement. What was particularly remarkable was that 118 of May’s own Conservatives voted against the agreement. This is the biggest rebellion by government MPs since the vote on the 2003 Iraq war (when 139 Labour MPs voted against going to war).

As expected, however, the vote did not provide any clarity about what positions would be supported by a majority. The following evening, May and her government had to face the vote of no confidence that had been tabled by Jeremy Corbyn, leader of the opposition and of the Labour Party, immediately after the Brexit deal had been rejected. This time, at least, May had the backing of the majority of the Tories plus Northern Ireland’s Democratic Unionist Party (DUP) and she notched up a small victory, winning the vote of no confidence in her Conservative government by 325 to 306. The reason why the majority of May’s party rallied round her and voted against the no-confidence motion was probably because barely any Conservative or DUP MPs want to see an early election. According to the latest polls, the Labour Party would be highly likely to win such an election.

How MPs voted

How MPs voted
Sources: Union Investment, The Economist, Hansard, as at 17 January 2019

Deadlock continues for now

It is clear that neither Prime Minister May nor the majority of MPs in the House of Commons want a no-deal Brexit. But it is unclear what the British people actually do want. Because of an amendment recently passed by parliament, May was required to submit a new proposal for an orderly Brexit to Brussels within three working days. But this ‘plan B’, which May presented to the House of Commons on Monday evening, proved disappointing and her speech did not mention any specific changes. Instead, she mainly emphasised what she did not want: postponement of the departure date and a second referendum. And she still did not rule out the UK leaving the EU without an agreement in place. Furthermore, she wants to relaunch negotiations with the EU on the particularly controversial issue of avoiding a hard border between the Republic of Ireland and Northern Ireland. Initial reactions from the EU indicate that it is not prepared to concede any ground on this matter. MPs are due to vote on plan B on 29 January.

May currently has three options. 1. Hold cross-party talks aimed at securing the necessary majority in favour of the withdrawal agreement reached with the EU after all. It is doubtful whether the Opposition would be willing to take part in such talks. After all, there is no reason for Corbyn to help May secure a negotiated majority by participating in the talks. His overarching aim is still for an early election to be called. 2. Enter into new negotiations with the EU in order to secure a unilateral right to terminate the backstop. That is what is set out in plan B. Some Brexiteers would then be likely to give their approval, enabling the modified withdrawal deal to be passed in the end. The backstop solution – the United Kingdom remains in the EU single market until a new customs agreement has been signed – is the biggest point of criticism for those in favour of Brexit. So far, however, the EU has vehemently refused to countenance any compromise on this matter. 3. Support a new referendum, although this is an unlikely scenario at present. A second referendum would not only take a very long time to organise but would also require parliamentary approval. There are currently no majorities in this respect (although the majority of the Labour Party is in favour of a second referendum). Moreover, May again ruled out this option on Monday evening.

Brexit timeline

Brexit timeline

Probable cross-party collaboration on a soft Brexit deal

Over the coming weeks, it will be interesting to see how the agreement’s opponents are divided up, i.e. how many of the no votes are attributable to the hard Brexiteers, how many to the soft Brexiteers and how many to the Remainers. At the moment, there are many indications that those in favour of a hard exit are in the minority. Conversely, there is a good chance of securing a cross-party parliamentary majority for a softer Brexit deal among the moderate MPs. For example, an agreement with the EU that is based on the Norwegian model is conceivable. The United Kingdom would become a member of the European Free Trade Association, which would include a customs union with the EU. The latter would also resolve the main problem of the EU’s external border between Northern Ireland and the Republic of Ireland.

In this context, it would also be conceivable that a number of individual motions would be put to the vote in the House of Commons and adopted by a cross-party majority comprising pro-European Conservative and opposition MPs. This would certainly be a complicated process. In terms of content, however, the outcome would be very similar to the withdrawal agreement currently being debated. There are many indications that this long and tortuous path will be the route taken. After all, the longer the deadlock continues, the more likely it is that MPs on both sides will stop toeing their respective party line. Ultimately, the opposition plus the pro-European Tory MPs will then form a parliamentary majority in favour of an agreement.

Measured response from the capital markets

The capital markets took May’s plan B in their stride. Their response to the rejection of the withdrawal agreement by the House of Commons had also been measured. Last week, pound sterling fell heavily against both the euro and the US dollar in the first instance. But it fully recouped its losses as trading continued. Bank shares also rose, and their gains of just over 1 per cent made them the winners among the components of the STOXX EUROPE 600 index.

British pound and bank stocks rather unimpressed

British pound and bank stocks rather unimpressed
Sources: Bloomberg, Union Investment, as at 22 January 2019

The markets’ response shows that many investors currently view a no-deal Brexit as the far less likely scenario. This is probably due, in part, to May’s fighting talk in the aftermath of the no confidence vote, in which she called for unity and repeated her invitation to politicians from across all parties to participate in talks. It is indeed conceivable that, over the coming days, some MPs will abandon their party-political manoeuvring in the national interest and help to find a constructive solution.

But it is also clear that further debate in the UK parliament and subsequent negotiations with the EU will take time. An extension of the deadline set out in article 50 of the Lisbon Treaty is therefore becoming more probable. So far, the EU has appeared reluctant to accept the UK remaining in the customs union after Brexit. But a workable solution now also requires concessions on the part of the EU. Individual EU member states have recently indicated that they would be willing to agree to the deadline being extended.

But an extension of the deadline will create complications for the European elections, which are taking place from 23 to 26 May. In preparation for the UK’s withdrawal from the EU, 27 of the UK’s 73 seats have already been reallocated to 14 other EU member states that are currently under-represented in the parliament (including France, Italy and Poland). The other 46 seats are to remain unoccupied for the time being, providing spare capacity in case the parliament is expanded in the future. If the deadline is postponed until the summer and the United Kingdom is still a member of the EU when the election is held, this will of course raise the question of what to do about the UK’s MEPs.

Conclusion: most likely scenario is a last-minute deal

An agreement can still be reached, thereby preventing the United Kingdom’s disorderly departure from the EU. But this is only likely to happen if a number of UK politicians are prepared to take a leap of faith and make substantial compromises. Our baseline scenario of a market-friendly departure from the EU by the United Kingdom – i.e. in accordance with a withdrawal agreement – therefore remains intact, despite the events of recent days. However, the timing of a possible agreement being reached is still unknown. The fear of failure probably has to reach tipping point before the UK – and the EU – will reach a last-minute deal.

Assessment by David F. Milleker, Chief Economist

 

Unless otherwise noted, all Information and illustrations are as at 22 January 2019.