Brexit policy uncertainty recalls Black Wednesday

For old hands, 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.

Prime Minister Theresa May has outlined three options for the country: Her deal, no deal or no Brexit at all. Each has very different implications for the economy and financial markets.

The withdrawal deal looks unlikely to make it through Parliament in its current form.

Conservative Brexiters and Remainers are unhappy about Britain’s potentially permanent rule-taker status, the Democratic Unionists do not want special treatment for Northern Ireland and the deal does not pass Labour’s six tests.

From an investment point of view, Brexit is about risk control rather than trying to predict the outcome.

According to Treasury estimates, the scenario closest to the government’s agreed deal would leave the economy about 4 per cent smaller 15 years from now when compared to staying in the EU, due to reduced migration and increased trade friction. That equates to about three years of lost growth. 

Mrs May argues these estimates are very uncertain, costs may turn out to be small and the economic hit is a price worth paying to stop free movement of workers and implement the result of the 2016 referendum.

However, some in her party are making the case for a no deal exit under new leadership as the only way to achieve full independence. Treasury estimates show this as the most damaging outcome of all, knocking an expected 8 per cent off the economy.

Interestingly, the offsetting benefit of making free trade deals with faster growing parts of the world is estimated at less than half of 1 per cent.

A no deal exit is not inevitable if the deal fails to clear Parliament. MPs could mandate a referendum with remaining in the EU on current terms as an option.

This possibility is more plausible in the light of the European Court of Justice's (ECJ's) preliminary ruling that the UK’s Article 50 notification to leave can be revoked unilaterally.

There would be no need to join the euro or Schengen and Margaret Thatcher’s rebate on contributions would be intact. Recent surveys suggest most people would opt to remain if such a vote were held today.

Three possible outcomes, none seems likely, but one of them has to happen. It is not surprising that sterling volatility has risen to its highest level since the referendum.

The pound would fall sharply in a no deal exit but it would strengthen significantly if the UK does not leave the EU after all. 

From an investment point of view, Brexit is about risk control rather than trying to predict the outcome. 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 those with a higher appetite for risk we balance equity holdings with property. The UK equity market should rally if the pound weakens on a no deal outcome, as in 2016, given the high proportion of earnings sourced from overseas. Property prices would rise sharply if Brexit were cancelled, however.

The events leading to a reversal of Brexit would undoubtedly mean increased market volatility in the short term but pressing on with Brexit, with or without a withdrawal deal, would mean years more uncertainty for investors as future trading arrangements are hammered out in fractious negotiations.

Black Wednesday was embarrassing for the government of the day but in hindsight most people, including then chancellor Norman Lamont, see the 1992 devaluation and sudden change of economic policy as a good thing – a White Wednesday. 

A democratically-backed decision to stay in the EU on current terms would lift the cloud of uncertainty dogging the UK and could boost the economy in a similar - and immediate - way.

Trevor Greetham is head of multi-asset at Royal London Asset Management