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United Kingdom Politics May 2019

United Kingdom: Theresa May resigns over Brexit impasse, risk of no-deal Brexit and general election rises

On 24 May, Prime Minister Theresa May announced that she would resign as Conservative leader on 7 June, paving the way for a contest to choose the next Conservative leader—and, by extension, the next prime minister. The contest is expected to conclude by the end of July. May’s decision came soon after talks with the Labour party broke down and her reworked Brexit proposals—which would have offered MPs a vote on whether to hold a second referendum—were fiercely criticized by members of her own party. The upshot is a creeping risk of both a no-deal Brexit and a general election, and intensifying political uncertainty, which will continue to hamper economic activity and put pressure on the currency in the near-term.

Boris Johnson, who has taken a hardline stance on negotiations with the EU, is viewed as the most likely candidate to succeed May. Victory for Johnson—or another pro-Brexit candidate—in the upcoming Conservative Party leadership elections would likely increase the risk of a no-deal Brexit.

This is all the more likely given that in the recent EU elections the newly formed Brexit Party gained a large share of the vote and Conservative support plummeted; this outcome could encourage the next Conservative leader to adopt a hard Brexit stance to recoup voters who switched to the Brexit Party. A no-deal Brexit could significantly hamper economic activity in the near-term.

According to Kallum Pickering, an economist at Berenberg: “the Brexit risks have shifted somewhat. As the UK has six months to sort out Brexit, and as a lot can happen between now and then, we adjust our projections modestly for now. We raise the risk of a hard Brexit to 25% from 20%”.

Even though most MPs are against a no-deal exit, they could struggle to find the legislative means to stop a government intent on no-deal, except through a no-confidence motion to bring down the government. As a result, May’s resignation increases the possibility of a general election.

According to analysts at JPMorgan: “MPs in the House of Commons will need to intervene to prevent “no deal” from occurring. Their ability and willingness to do so is probable, but far from guaranteed. Deadlock between the executive and the House would point to a new general election before the end of the year.”

In order to secure time to hold another election, a further extension to Article 50 beyond the current end date of 31 October could be required. Moreover, as the Conservative leadership contest will take several months to complete, it is possible that a new prime minister could request an extension to allow more time to negotiate with the EU—despite some Conservative candidates currently talking up the possibility of a no-deal exit in October.

As Adrian Paul, an economist at Goldman Sachs, comments: “we expect PM May’s successor to emerge from the Eurosceptic wing of the Conservative Party, intent on returning to Brussels to re-open the Withdrawal Agreement. […] In response, however, we think the EU-27’s stance will remain unchanged, […] we think PM May’s successor will then run into a familiar impasse in the run-up to the 31 October Brexit deadline and eventually ask the EU-27 for a further Article 50 extension”.

However, a further extension is not a done deal. As James Smith, an economist at ING, cautions: “there’s a risk the EU’s stance gradually begins to harden. France, in particular, has been highly resistant to allowing the process to go on for much longer without resolution. If the wave of UK MEPs from the newly-formed Brexit party seek to disrupt the process of appointing leaders to the top Brussels jobs over the next few months, there is a risk that this hardline stance towards further Brexit extensions could broaden out to other member states.”

All in all, recent developments point to a higher probability of a no-deal Brexit, a general election and a second extension to Article 50, and a lower probability of a Brexit deal being agreed before 31 October. As a result, business investment is likely to be suppressed for much of the year. Although business investment did rise in Q1 following four consecutive quarters of contractions, this turnaround could be short-lived.

Moreover, the pound—which has lost notable value in recent weeks—will likely remain under pressure. According to economists at UniCredit: “the notion that a pro-Brexit candidate winning a leadership race to replace Theresa May as party leader will likely increase the risk of a no-deal Brexit has started to receive more attention. We have been warning for a while that this would likely put pressure on sterling, and we see risks of GBP extending its move to the downside unless her successor strikes a more conciliatory tone”.

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