Investment Clock insights

What if Brexit is cancelled? Echoes of Black Wednesday in 1992


Trevor Greetham

7 December 2018

First published in Investment Week on 7 December 2018

Brexit is the gift that keeps on giving when it comes to uncertainty. 
It is nearly two and-a-half years since the EU referendum and yet we still do not know what will happen. Almost anything seems possible but nothing seems likely. For those of us who have been in the markets a while, the degree of uncertainty over the future path of government policy calls to mind the days running up to Black Wednesday in September 1992, when the UK attempted to raise base rates twice to defend the pound before crashing out of the Exchange Rate Mechanism.
The UK could leave the European Union in March 2019 under something close to Theresa May's withdrawal agreement. The UK could leave with a different deal after a period of re-negotiation. The UK might leave with no deal and no transition period in a cliff-edge and disruptive exit. Recently it has become increasingly plausible that the UK holds a referendum on the final deal and does not leave at all. Each of these scenarios has very different implications for investments and the exchange rate and it is almost impossible for forecast what will happen, even on a day-to-day basis.
The government's deal looks unlikely to get through Parliament, as Conservative Leavers and Remainers are seemingly unhappy with the ‘rule-taker' status it would leave Britain in during the transition period and potentially forever, if the customs union backstop becomes a minimum basis for future negotiations, as seems likely. The Democratic Unionists are opposed to any special treatment for Northern Ireland. Scottish MPs want special treatment as their country voted to remain in the EU. Meanwhile, Labour has described the agreed deal as a dismal failure which doesn't pass its six tests, although the opposition hasn't proposed an alternative plan that would come close to being acceptable for the EU.
In one sense, Theresa May has indeed succeeded in uniting the country – In opposition to the type of Brexit actually on offer. And remember, this is only the withdrawal agreement. The political declaration on a future relationship was left wide open, a so-called Blind Brexit that would set another countdown clock ticking. If recent history is any guide, most if not all of the transition period would be spent with arguments raging around the Cabinet table and the EU left bemused and on the side-lines.
Uncertainty on this level is not a good thing. Business investment is already declining sharply and service sector confidence has fallen to its lowest level since the EU referendum. The UK economy might even fall into a mild recession if it weren't for the short-term positive effect of stock piling as manufacturers and households buy in goods ahead of possible shortages.
Parliament is trying to take back control from the minority government, setting the scene for a full blown constitutional crisis, but there is no majority among Members of Parliament for any other course of action. Certainly, MPs do not feel comfortable cancelling Brexit using the authority delegated to them by the electorate. Likewise, they do not want to be responsible for food and medical shortages and queues at the ports.
There will be an attempt to get further concessions from the EU, although these are likely to be very limited. There may also be a move to pursue a much softer Brexit like Norway Plus, full single market and customs union membership. This option would be less damaging for the economy but Brexiters won't like the fact it means accepting free movement and we wouldn't be able to make our own trade deals. Meanwhile, Remainers would point out it means being in the single market and following all EU regulations without having any say in them. As former Prime Minister Tony Blair puts it, if we leave the EU the choice is between a painful Brexit and a pointless Brexit.
When presenting her deal, Theresa May says the country has three options: her deal, No Deal or no Brexit at all. The mention of No Deal was intended to scare Remainer MPs into backing her deal. The mention of No Brexit was intended to scare Leavers into backing it. The reverse seems to have happened. Hard line Leavers were encouraged to hear that a full severing of ties is still possible. Remainers heard for the first time that we might yet stay in the EU.
The probability that Brexit is cancelled was significantly boosted this week when the European Court of Justice published an opinion saying the UK could probably revoke its notice to leave the EU under Article 50 unilaterally.
The Advocate General said the two year period before the UK is due to leave could be seen both as a negotiation period and a "cooling off period".  The significance here is that the UK could decide simply to cancel its notice to leave, reverting to full EU membership under current terms. Margaret Thatcher's rebate would be intact and there would be no pressure to join the euro or Schengen. David Cameron's concessions might also be back on the table, freezing in-work benefits for new EU migrants, insulating the UK from euro-related transfers and excluding it from further political integration.
It's not surprising that the Brexit endgame has pushed sterling volatility to its highest level since the 2016 referendum. The pound would fall sharply if a No Deal exit with no transition period becomes a realistic prospect but it would rise sharply if the UK remained in the EU.
From an investment point of view, it will be almost impossible to predict the outcome so Brexit is about risk control. For UK-based investors with a low risk appetite it makes sense to avoid or to hedge overseas currency exposure until things settle down. For investors with a longer time horizon we balance equity holdings in our multi asset funds with exposure to commercial property. Equities are likely to do best if the pound weakens on a No Deal outcome. Property would do best in a closer relationship with the EU.
We are in for a fraught few weeks. With less than six months to go investors still don't know the framework that will determine UK economic policy for many years to come. To quote Winston Churchill, no-one pretends democracy is perfect or all-wise. However, in the end there will be a settled and agreed course of action weighing up all of the alternatives actually on offer. Parliament and the public may conclude that the UK's semi-detached position, inside the EU but outside of the euro, is not so bad after all.
The events leading to a reversal of Brexit would be difficult and we'd undoubtedly see increased market volatility in the short term but there are no easy options. Pressing on with Brexit would mean years' more uncertainty. Black Wednesday was embarrassing for the government of the day but it allowed the Bank of England to cut interest rates to boost a recessionary economy. In hindsight most people, including then chancellor Norman Lamont, see the 1992 devaluation and policy rupture with Europe as a good thing – a White Wednesday.
There are parallels today, but in reverse. This time it is staying in a close policy relationship within the EU that would lift a cloud of uncertainty, boosting the economy in a similar and immediate way.

Anything seems possible but nothing seems unlikely. Brexit is the gift that keeps on giving when it comes to uncertainty. 

It is nearly two and-a-half years since the EU referendum and yet we still do not know what will happen. Almost anything seems possible but nothing seems likely. For those of us who have been in the markets a while, the degree of uncertainty over the future path of government policy calls to mind the days running up to Black Wednesday in September 1992, when the UK attempted to raise base rates twice to defend the pound before crashing out of the Exchange Rate Mechanism.

The UK could leave the European Union in March 2019 under something close to Theresa May's withdrawal agreement. The UK could leave with a different deal after a period of re-negotiation. The UK might leave with no deal and no transition period in a cliff-edge and disruptive exit. Recently it has become increasingly plausible that the UK holds a referendum on the final deal and does not leave at all. Each of these scenarios has very different implications for investments and the exchange rate and it is almost impossible for forecast what will happen, even on a day-to-day basis.

The government's deal looks unlikely to get through Parliament, as Conservative Leavers and Remainers are seemingly unhappy with the ‘rule-taker' status it would leave Britain in during the transition period and potentially forever, if the customs union backstop becomes a minimum basis for future negotiations, as seems likely. The Democratic Unionists are opposed to any special treatment for Northern Ireland. Scottish MPs want special treatment as their country voted to remain in the EU. Meanwhile, Labour has described the agreed deal as a dismal failure which doesn't pass its six tests, although the opposition hasn't proposed an alternative plan that would come close to being acceptable for the EU.

In one sense, Theresa May has indeed succeeded in uniting the country – In opposition to the type of Brexit actually on offer. And remember, this is only the withdrawal agreement. The political declaration on a future relationship was left wide open, a so-called Blind Brexit that would set another countdown clock ticking. If recent history is any guide, most if not all of the transition period would be spent with arguments raging around the Cabinet table and the EU left bemused and on the side-lines.

Uncertainty on this level is not a good thing. Business investment is already declining sharply and service sector confidence has fallen to its lowest level since the EU referendum. The UK economy might even fall into a mild recession if it weren't for the short-term positive effect of stock piling as manufacturers and households buy in goods ahead of possible shortages.

Parliament is trying to take back control from the minority government, setting the scene for a full blown constitutional crisis, but there is no majority among Members of Parliament for any other course of action. Certainly, MPs do not feel comfortable cancelling Brexit using the authority delegated to them by the electorate. Likewise, they do not want to be responsible for food and medical shortages and queues at the ports.

There will be an attempt to get further concessions from the EU, although these are likely to be very limited. There may also be a move to pursue a much softer Brexit like Norway Plus, full single market and customs union membership. This option would be less damaging for the economy but Brexiters won't like the fact it means accepting free movement and we wouldn't be able to make our own trade deals. Meanwhile, Remainers would point out it means being in the single market and following all EU regulations without having any say in them. As former Prime Minister Tony Blair puts it, if we leave the EU the choice is between a painful Brexit and a pointless Brexit.

When presenting her deal, Theresa May says the country has three options: her deal, No Deal or no Brexit at all. The mention of No Deal was intended to scare Remainer MPs into backing her deal. The mention of No Brexit was intended to scare Leavers into backing it. The reverse seems to have happened. Hard line Leavers were encouraged to hear that a full severing of ties is still possible. Remainers heard for the first time that we might yet stay in the EU.

The probability that Brexit is cancelled was significantly boosted this week when the European Court of Justice published an opinion saying the UK could probably revoke its notice to leave the EU under Article 50 unilaterally.

The Advocate General said the two year period before the UK is due to leave could be seen both as a negotiation period and a "cooling off period".  The significance here is that the UK could decide simply to cancel its notice to leave, reverting to full EU membership under current terms. Margaret Thatcher's rebate would be intact and there would be no pressure to join the euro or Schengen. David Cameron's concessions might also be back on the table, freezing in-work benefits for new EU migrants, insulating the UK from euro-related transfers and excluding it from further political integration.

It's not surprising that the Brexit endgame has pushed sterling volatility to its highest level since the 2016 referendum. The pound would fall sharply if a No Deal exit with no transition period becomes a realistic prospect but it would rise sharply if the UK remained in the EU.

From an investment point of view, it will be almost impossible to predict the outcome so Brexit is about risk control. For UK-based investors with a low risk appetite it makes sense to avoid or to hedge overseas currency exposure until things settle down. For investors with a longer time horizon we balance equity holdings in our multi asset funds with exposure to commercial property. Equities are likely to do best if the pound weakens on a No Deal outcome. Property would do best in a closer relationship with the EU.

We are in for a fraught few weeks. With less than six months to go investors still don't know the framework that will determine UK economic policy for many years to come. To quote Winston Churchill, no-one pretends democracy is perfect or all-wise. However, in the end there will be a settled and agreed course of action weighing up all of the alternatives actually on offer. Parliament and the public may conclude that the UK's semi-detached position, inside the EU but outside of the euro, is not so bad after all.

The events leading to a reversal of Brexit would be difficult and we'd undoubtedly see increased market volatility in the short term but there are no easy options. Pressing on with Brexit would mean years' more uncertainty. Black Wednesday was embarrassing for the government of the day but it allowed the Bank of England to cut interest rates to boost a recessionary economy. In hindsight most people, including then chancellor Norman Lamont, see the 1992 devaluation and policy rupture with Europe as a good thing – a White Wednesday.

There are parallels today, but in reverse. This time it is staying in a close policy relationship within the EU that would lift a cloud of uncertainty, boosting the economy in a similar and immediate way.

Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.