What No-Deal Brexit means for the Financial Markets
Analysis of https://www.theguardian.com/business/2020/dec/13/financial-markets-brace-for-volatile-week-as-brexit-uncertainty-continues by Graeme Wearden.
With the no-deal Brexit deadline drawing closer the UK and EU warn that no-deal Brexit is likely; however, with trade talks still occurring some speculate that the chances of a trade deal are rising once again.
What does this mean
With an initial deadline of the 31st of December, failure to reach an agreement by then would result in a no-deal Brexit. No-deal Brexit would mean that the UK would exit the EU without a free trade agreement. This has many implications for the future of trade between the UK and the rest of the EU. Including imposition of tariffs and drops in equities and the currency.
My take on the article
With the rising uncertainty over whether or not a trade agreement will be reached, the Financial Markets are preparing for potentially volatile coming weeks. This is understandable given the already witnessed plunge in stocks and the pound, prior to the announcement to ‘go the extra mile’ and continue the trade agreement discussion. The looming December 31st deadline threatened a highly likely no-deal Brexit result, while this is still probable, the pound is making a minor recovery post continuation of trade talks announcement.
The article goes on to predict that the pound will ‘plunge against the the US dollar in a no-deal scenario to around $1.15’. However, the part I would like to focus on is the predicted drop below parity with the Euro only mentioned in passing. I find this to be a more intriguing possibility. The fact that our domestic currency could sink below parity as a result of a no-deal exit holds many consequences that can be explained in economic terms.
With the Euro-Pound exchange rate forming a so-called ‘textbook bullish price pattern’ the purchasing power of the Pound will likely fall against that of the Euro (see fig 1). While changes in exchange rates may not always represent changes in the standard of living, the Purchasing Power Parity compares the costs of goods between countries and therefore acts as an arguably better measure of economic performance.
Regardless, this will inevitably influence aggregate demand through its effect on net trade. Following a decrease in the exchange rate (as predicted post no-deal Brexit) a counterintuitive rise in aggregate demand would occur. Imports would become more expensive for domestic consumers and our exports would become cheaper for people using the Euro to purchase. Essentially exports increase while UK consumers buy fewer imports (decreasing import expenditure).
I will talk separately about tariffs and their inhibitions on my previously stated increase in aggregate demand due to higher net trade after I mention the impact of depreciating exchange rates on the UK current account.
With export revenue increasing (inflows) and import expenditure (outflows) decreasing, the current account will increase (improving the UK current account deficit bringing it closer to equilibrium).
Contrary to what I said before, Aggregate demand may not necessarily increase. It should be kept in mind that in the case of a no-deal result, tariffs imposed by the EU on UK exports are likely to put serious pressure on some industries and will in fact reduce exports as foreign consumers are discouraged by the high taxes.
With all the World Trade Organisation’s trade terms (implemented in a no-deal scenario) the British economy can expect to be affected on a Microeconomic level to the same extent. Figure 2 shows that 50% of UK business leaders (row 5) predict that the WTO trading agreements will have negative consequences for their company.
I also feel the need to comment on the closing statement of the article where they stated that ‘shares in UK companies would likely plunge in a no-deal scenario’. In reference to the UK FTSE 100 I would agree to an extent, however, I think there are several exceptions to this statement. Examples like Ocado and Hikma Pharmaceuticals are both classic defensives whose share prices will probably remain stable. While I can’t name any by name, many internationally diversified companies are likely to remain relatively stable throughout the whole no-deal Brexit process as well.
Overall I’d conclude that the impacts which the article describe mainly affect imports and exports but due to the ambiguity of the situation it's not certain whether the aggregate demand curve for the UK will shift inwards or outwards, only time will tell.
