UK: A hard Brexit isn't remotely priced

Oliver Harvey, Macro Strategist at Deutsche Bank, suggests that the last week’s UK Q2 balance of payments data from the ONS makes interesting reading in light of the recent further weakness in the pound.

Key Quotes

“While the UK’s current account deficit was relatively stable at current record wide levels, net portfolio inflows picked up sharply to GBP 105bn in the quarter, largely due to foreign purchases of UK fixed income. FDI inflows were near flat in after decent inflows in Q1. On a four quarter basis, the UK’s broad basic therefore remains close to recent record highs. Of course, this encompasses only a brief post-Brexit period, but a more timely measure from the Bank of England of foreign purchases of UK gilts shows that save for one month in July foreigners have been persistent buyers of UK bonds over the summer.

Official data thus provides a different picture of investor sentiment than the record sterling shorts shown by IMM positioning, and is more in tune with our proprietary CORAX report which shows more net buying than selling of sterling since the referendum. If this suggests the market was anticipating a relatively benign outcome from the UK’s forthcoming renegotiation, political developments from the Conservative Party Conference this week will have come as more of a shock. Hard Brexit has become a meaningful risk, with Prime Minister May tying herself to a deadline of end-March 2017 to trigger Article 50 and prioritizing immigration and sovereignty from the ECJ – both incompatible with continued Single Market membership.

Our takeaway from the conference was that May believes the threat of rebellion from hard-line eurosceptic Conservative MPs is significantly greater than from the more centrist wing of the party or a divided opposition – the corollary being a much tougher negotiating stance. The risk is that this does not play well with EU partners, particularly given French and German elections next year.

With political risks growing and much of the flow impact yet to be felt, we remain bearish sterling as per our recent Blueprint recommendation.”

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