Brexit goes to overtime

We think the probability of Prime Minister May's deal passing on 12 March is low (15%), although we have seen some softening lately in the Brexiteers' position on the backstop. The defeat, however, may be smaller than in January and media report that May is already planning a third attempt as soon as 18 March. Some Brexiteers fear voting May down will result in a softer, not a cleaner/harder, Brexit. So far the DUP has not jumped on board, which, in our view, would be a big game changer (as many Brexiteers would likely follow suit). If the deal passes, the EU27 can sign it off at the EU summit on 21-22 March, but the UK would probably still need a short extension in order to pass the necessary secondary legislation. If, against our expectation, the deal is passed, we expect EUR/GBP to move down to 0.83.

We think the probability of the House of Commons voting in favour of a ‘no deal' scenario on Wednesday 13 March is very slim, likely 5%. This, however, is not the same as the final outcome will be no deal. Some politicians think this step is necessary to keep the pressure on the EU27. Still, this scenario would be GBP negative and we think EUR/GBP will move back to the old 0.87-0.90 range. Eventually, if the UK crashes out without a deal, we expect EUR/GBP to move towards parity, at 1.00.

Our base case is that the House of Commons will vote in favour of asking the EU27 for an extension of Article 50 (95% probability) on Thursday 14 March. It is still up to the EU27 leaders to unanimously accept the proposal and the leaders are divided on whether to accept an extension, and if so, how long it should be. While Tusk is in favour of a very long extension, France's President Macron does not sound like he would support an extension unconditionally. As an extension seems to be priced in already, we think the potential for another move lower in EUR/GBP is limited. From a technical perspective, there also seems to be considerable support around the 0.85 mark. We expect EUR/GBP to move a bit lower towards, but not below, the 0.85 mark.

In the event of an extension, the battles are just postponed by two or three months and it is not a given that things would change dramatically from here, at least not in the very near term. This means that EUR/GBP would stay around the current level and we may even see a slightly higher spot level, as we cannot rule out markets starting to worry about a no deal outcome again (and UK macro data will likely remain weak, see next page).

Some still need to compromise and change their views eventually – who blinks first, the moderates or the Brexiteers? We think it is going to be the Brexiteers, which is why we stick to our long-held view that May's deal will pass eventually. When we get Brexit clarification, we foresee EUR/GBP moving down to 0.83. In the event the UK needs to extend further when we reach May, we think the EU will be reluctant to agree unless the extension is very long, possibly until year-end 2020.

Alternatively, we expect the moderate MPs from different parties could combine, forcing May to call for a second EU referendum. This would also lead to a stronger GBP, as polls show a small, but not insignificant, lead for remain.

For a simple overview of the different possible outcomes please see game tree, page 3.

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