Boris Johnson has been announced as the new leader of the Conservative Party. With around 66% of the votes of Conservative members, Johnson defeated run-off rival Jeremy Hunt. By extension, today he has taken over from Theresa May as the next UK Prime Minister. Where does this leave the state of Brexit and the outlook for sterling?
For weeks now, financial markets have been worried about the prospect of a more euro-sceptic Prime Minister taking over from Theresa May. Boris Johnson has been a clear front runner throughout the campaign to be the next Conservative leader/UK Prime Minister. Sterling has been under pressure throughout the past few weeks, losing over 5% of its value against both the US dollar and the euro. What do we need to consider for Boris Johnson’s next moves?
There are a few things that need to be considered:
- How does Boris deal with Brexit?
- Will Labour leader Jeremy Corbyn call a vote of confidence?
- How will the Bank of England respond?
The prospects for Brexit
Johnson can be seen as all bluff and bluster. He has seemingly preferred to spend the last few weeks of the leadership campaign confounding people with his mastery of linguistics, rather than giving straight answers to straight questions. However, he has threatened to keep the prospect of leaving the EU with no deal on the table. On the campaign trail Boris said that the UK would leave the EU on 31st October “do or die”. Whilst being a viable tactic of negotiation, the prospect of the UK leaving the EU on the 31st October without a deal is a significant concern for financial markets. Traders have had to price in the increased probability of a disorderly Brexit into sterling (hence the 5% decline).
So, is a hard Brexit set to happen?
Well, Boris has just under 100 days to get a deal and prevent leaving the EU with no deal. To prevent a hard Brexit, he will have to work fast to cobble together some sort of deal from the EU. Perhaps a realistic threat of “no deal” will be a slap in the face that brings the EU around. However, unless Johnson accepts much of what Theresa May negotiated, a substantially different deal appears to be a pipe-dream.
Whilst the EU’s Barnier has been welcoming to Johnson’s victory, the prospect of drastic change to what was agreed with Mrs May is slim. France’s Macron was said to be close to using his veto back in March when Article 50 was extended, and he will remain a key stumbling block again. The EU are likely to adopt a largely “take it or leave it” stance, with very little likely to be achieved in renegotiation. There are very few signs that the EU is willing to bend on the Irish Backstop, the crucial sticking point of the Withdrawal Agreement that is currently on the table. Suggestions of removing the backstop will likely be met with a short shrift from chief EU negotiator Barnier and his team. Perhaps though there may be some wriggle room on the transition period being extended to allow more time to find viable solutions.
We see two possible scenarios playing out here. Firstly, Boris accepts minor tweaks to the deal. Parliament accepts this with a view to it being the only viable way to prevent a no deal Brexit. Brexiteer MPs will take a pragmatist view that they are better positioned with a “leaver” as Prime Minister for the second phase of negotiations, the trade talks. However, the alternative scenario is that Johnson pushes for a no deal Brexit. However, this would almost certainly result in a General Election. We view an accepted deal tweak as more likely. Assuming that not only Conservative but also Labour MPs too have the capacity to act rationally, they would view this as better than the massive political minefield of a General Election. A General Election without Brexit having been delivered would be open season for not only the Brexit Party but also potentially the Liberal Democrats.
With the country extremely bitter at the prospect of Brexit not having been delivered, whilst both main parties are split down the middle, it could be an election where almost anything could happen. The latest polls (above) are all over the place right now. However, equally, this is more palatable than the UK leaving the EU with no deal. At that stage, Parliament would move to prevent this through a vote of confidence, that Johnson would almost certainly lose, thus most likely resulting in a General Election.
So given how steadfast Boris has been on saying that the UK will leave on 31st October, the prospect of no deal is elevated. However, might it not come to that at all? A General Election could kick the Brexit can once more down the road.
Corbyn to sit on his hands, for now
The potential has been that given the supposed public and political backlash that comes with Johnson as Prime Minister, that the Labour Party would immediately look for a vote of no confidence in the Government.
In the House of Commons, as a result of defections and by-elections, according to the Parliament website, the Conservative Government has a working majority of zero. Below is a table from the Parliament’s own website www.parliament.uk which shows the current composition of the House of Commons. This leaves the Government very much at risk of falling to an Opposition vote of confidence. We see this to be the most likely course of events to unblock the Brexit log-jam in 2019. The only issue is when?
The immediate prospects of a confidence vote succeeding look unlikely though. Parliament goes into summer recess at the end of this week and there would need to be a confidence vote brought by 25th July (Thursday) to be seen in the near term. It is highly unlikely that given that Conservative MPs would surely give Johnson time to lay his cards on the table, whilst confidence and supply partners from Northern Ireland, the DUP would welcome a more euro-sceptic Prime Minister. The signs are that the more moderate, remain-leaning wing of the Conservative Party are keeping an open mind for now. Key figures such as (soon to be ex) Chancellor Hammond have indicated that whilst Johnson pushes for a deal that he would command their support. Former leadership (and very much remain supporting) candidate Rory Stewart has been less clear of his support, but remains on-side for now.
As a result, it is unlikely that Opposition Leader Jeremy Corbyn will call a confidence vote this week. However, he surely will before 31st October. So, if not now, then when?
Whilst Johnson does not push for a “no deal” Brexit, he should retain the confidence of his own MPs. In the event that he survives the next couple of days without a confidence vote, the timetable for a general election becomes incredibly tight before the 31st October deadline for the EU to leave the EU with a deal. The next available opportunity for a confidence vote would be 3rd September, which is when Parliament returns from summer holidays. This is possible, as Johnson would have had a few weeks to lay out his plans for a deal to the EU and perhaps an idea of progress will be known. If it is clear the EU will not budge and that Mrs May’s deal is still the only viable option on the table, then Johnson could go for the nuclear option. This would be the time for Corbyn to go with a confidence vote.
However, even if Parliament succeeds in bringing down the Johnson Government straight away in early September, the earliest date to dissolve Parliament would be Thursday 19th September. This leaves five weeks for a General Election campaign and the date of the election would be Thursday 24th October. Given the timeline, we expect Corbyn would bring a vote of confidence in the first week after the summer break (the Government losing the Brecon and Radnorshire by election could be the swing factor). A successful vote of confidence would not see a stable government formation and inevitably then bring about a General Election.
Whoever wins the election would have just a week before the UK is due to leave the EU on 31st October. That leaves a “no deal” Brexit (on a Conservative election victory) or another extension to Article 50 (if Labour wins) as the two viable outcomes under the scenario of a General Election prior to 31st October.
Impact on the Bank of England monetary policy
Prime Minister Johnson has increased the potential for a no deal Brexit. The Bank of England is taking note. BoE speakers are increasingly talking about the impact on monetary policy of a no deal Brexit. It is seen that a chaotic Brexit would sap confidence from the UK economy. A significant initial hit to the economy would still be likely, if nothing else due to the massive uncertainty surrounding the UK’s trading relationships.
The MPC’s Gertjan Vlieghe was the first MPC member to openly discuss the impact of Brexit on the level of interest rates. On 12th July, Vlieghe said that a “no deal” Brexit would result in the Bank of England being required to cut interest rates almost back to zero (from the current +0.75%). He even suggested that in the event of further delays to Brexit, the uncertainty for the UK economy could also result in rate cuts being necessary. However, he also talked about scenarios where a deal was achieved, thus averting a chaotic Brexit. In this case, that if a deal were to be achieved then the Bank of England would be able to raise rates to +1.0% over the next year, to +1.25% in 2021 and to +1.75% in 2022. The caveat to this was the dependence on the global economy recovering from its recent slowing trend.
Another MPC member, Michael Saunders, who is also a notable hawk on the rate setting committee, on 23rd July suggested that the Bank of England was not “bound by forecasts implying rate hikes”. He noted that the UK economy was “weak” and “not overheating”. These comments are also dovish, whilst Saunders also suggested that the UK leaving the EU with no deal would be sterling negative.
Whilst being nothing ground breaking, this all suggests that the MPC is less than sanguine over the prospects of a “no deal” Brexit and rate cuts would result. This helps to cement the sterling negative outlook in this scenario.
Market impact for Cable