- EU leaders convene in Brussels and aim to hammer out a Brexit deal.
- The outcome depends on the instant reactions and not only on the deal.
- Five different scenarios could send GBP/USD to considerably different prices.
"Get Brexit done" was the Conservative Party's conference slogan – but it is easier said than done. To make it happen, Prime Minister Boris Johnson needs to find a formula that both the EU and parliament agree on. The EU Summit on October 17-18 may also see other results, ranging from a short extension to a total collapse in talks.
At the time of writing, unconfirmed reports suggest a Brexit deal is imminent, and GBP/USD hit fresh three-month highs. However, "it ain't over until the fat lady sings."
Here are five scenarios:
1) A deal is reached and hardliners back it
In this scenario, the PM convinces the Brexiteers that letting NI drift away – proposals that he objected in the past – is the best possible option to get Brexit done. Labour MPs from Leave-voting constituencies to back it, and it is then set for sailing through parliament on Saturday, October 19.
GBP/USD would surge and perhaps hit 1.32. The probability is medium.
Markets desire a soft deal – perhaps the Norwegian model – and preferably no Brexit at all. However, the pound has been pricing in a no-deal as late as September, and its recovery does not price in an accord – just a short delay. The rally we have seen may only be the beginning.
2) Deal without support
The DUP may convince Conservative hardliners to reject the agreement, and Labour MPs would refuse to back a "Tory Brexit" in this scenario. However, all sides may agree that elections are the way out – and the UK asks for an extension. Johnson may be convinced that a new House of Commons would provide the seal of approval.
In this case, the pound may drift lower on uncertainty, but not collapse. It could undo the recent gains and fall to around 1.22. The probability is medium-high.
A victory for Johnson may seal the deal, while a Labour-Liberal Democrat win may trigger a second referendum and eventually revoke Brexit. Despite uncertainty and markets' preferred options, the downside is limited.
3) Agree to meet again soon
London and Brussels may conclude that substantial progress has been made but not enough to declare victory. The idea of an emergency summit – before the end of October – has already been floated and may turn into reality. In this scenario, both sides agree to continue with around-the-clock talks to finalize the accord by the date of the summit.
Brexit would be delayed in this scenario – but only by a few days or weeks. While the PM would be forced to ask for an extension until January 31, 2020, the EU would grant only a short delay, in the spirit of getting a deal done shortly.
This scenario, which has a high probability, would probably keep GBP/USD at the current broad range of 1.26 to 1.2750.
It would be a continuation of the current situation.
4) No agreement and forced extension
If the UK and the EU fail to agree on a pathway to Brexit, Britain will be on course to ask for an extension – but more significant uncertainty may send it lower – even if an imminent no-deal is averted.
In this scenario, Johnson is forced to ask for a three-month extension, but the EU decides on a delay until June 2020. That would open the door to holding a second referendum – which requires time to organize – but markets may be wary of the endless drag.
This scenario, which has a low probability, will probably send the pound gradually lower, perhaps initially to 1.23-1.24, and then further down as economic data weigh on it.
5) A total breakup of talks and a hard Brexit
If this significant push to reach a deal fails, the EU may be growing tired of endless Brexit negotiations – just like the British public.
Even if the PM fails to circumvent the Benn Act and ask for an extension – he may get the EU to reject it. They may not require his help.
French President Emmanuel Macron and other leaders may want the UK to get over with it and leave – even if the price is economic damage.
This scenario of a no-deal Brexit has very low probability – and would send GBP/USD plunging to 1.10.
The Brexit talks are at a delicate stage, and GBP/USD is already experiencing high volatility. The situation may change rapidly around the EU Summit and go in the five scenarios listed above.
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