Markets Shudder Under Threat of Hard Brexit

Theresa May has been the conservative leader and Prime Minister of the UK for just over 6 months following the Brexit vote in June of last year.  Since then, the discussion over just how the UK might go about the Brexit from the European Union has left markets, the pound sterling and multinationals focused on trade in the dark.

That is all about to change.

The Prime Minister will meet in front of a scattered mix of government members, press and European diplomats at London’s Lancaster House to outline Brexit priorities going forward on Tuesday.  The house was once the location in which the UK signed over independence to Zimbabwe (then Rhodesia), Malaya and began negotiations with South Africa to become a republic — so it is only fitting that such a public speech would take place in front of the London mansion.

Prior to the scheduled speech, Mrs. May had only given one major public address covering Brexit and expectations, while standing in front of her fellow conservative party members. There she announced that she would be working toward EU migration controls and directly working toward the legalities surround the European Court of Justice.

PM May has then signaled that by March, less than ten weeks time, she plans to trigger the EU’s article 50 that would formally begin the UK’s exit from its European commitments with the Union.

Currently, an estimated 44% of the UK’s goods and services sector are being exported to the EU, while an astonishing 53% of imports to the UK come from the EU.

On Sunday, British newspaper The Telegraph reported, “sources familiar with the prime minister’s thinking” suggest that PM May would select a “hard Brexit” in direct contrast to possible protections of the economy.

After the commentary the British pound sterling has has an all time 31-year low against the U.S dollar, with the exception of last October and the flash crash experience.  The separation between the UK and the 27 remaining UK member states could extend beyond currency triggers and levy devastating impacts on the private sector and global markets.

While the pound sterling has taken a dive, gold has experienced an 8-week high with investors spooked with uncertainty regarding what the anticipated Brexit speech might reveal. This move in gold comes at a time when trade and jobs from the UK are under wide uncertainty.

Jim Rickards noted at the end of last year, “Brexit is certain to impose large costs on the UK economy mostly in the form of reduced trade with the EU, tariffs, and an exodus of jobs and capital from the City of London as major banks move their offices to Frankfurt, Amsterdam, Dublin or Paris.” If the realities of the hard Brexit takes hold, this capital shift from London could rock markets and be proper cause for investors to seek more reliable opportunities outside of the UK.

The “muddled thinking” that outgoing British ambassador to the UK publicly denounced earlier this month regarding Brexit methods are widely anticipated to be clarified in the Prime Minister’s speech.  The British people, and to an even wider extent the rest of the EU, will be watching this speech for greater specifics  – even if that means a hard Brexit reality is on the horizon.

The three likely outcomes from the UK giving up its membership to the EU market are worth considering.

First, it could establish that London would be able to trade with the European Union under the guise of the World Trade Organization, while also having to meet specific export and import requirements with WTO tariffs.

Second, London could establish a “free trade” memorandum with Brussels, the European de-facto capital, that would allow for trade involving as many products and services as it deems appropriate.

Third, the UK could negotiate an agreement in which tariffs be arranged within the EU customs union – ultimately allowing minimal disruptions to trade with continental Europe.

These options were only further affirmed when the UK’s chief financial minister told a German editorial over the weekend that, “If Britain were to leave the European Union without an agreement on market access, then we could suffer from economic damage at least in the short-term.”

While all options on the table, the current government could apply any mixture of approaches – but leaving the market and current its trading partners in the dark is an uncertainty that both the UK nor EU cannot afford.

As Nomi Prins noted in her financial outlook for 2017, “The sterling fell 14% in 2016, due to Brexit and anxiety over what form it will eventually take.  Despite a year-end dead-cat bounce, uncertainty can only mount once negotiations truly begin.”

The signals from PM May showing the setup for a hard Brexit or otherwise will all be worth monitoring and adjusting for. While one speech, and even the eventual enabling of Article 50 to separate from the EU, will be an evolving process ― the precedent set will offer a clear picture to those Eurozone members also considering a split.

The outcomes of how the UK and the EU negotiate an exit will be observed meticulously by those Euroskeptic groups considering a departure of their own governments. Divorces are never easy things, the romance between the UK and the EU was never going to be a pretty ending – even if it is an “it’s not you, it’s me” Brexit split.

Regards,

Craig Wilson, @craig_wilson7
for the Daily Reckoning