With the European Union (EU) agreeing to extend the UK’s Brexit deadline by six months to October 31, critics of the Conservative Party might argue that the two extra quarters afforded in which to strike a new deal have in reality become one, given that the first quarter has been taken up with the Conservative leadership election.
While the Spice Girls have undertaken their global reunion tour, over the course of the Conservative Party leadership contest, we have seen a dozen or so ‘wannabes’ whittled down to just two, and now one, as Boris Johnson becomes the new British prime minister. Pro-Johnson Conservative politicians and party members will be fervently hoping that he will not only ‘spice up’ a divided party, but also re-energize the UK’s Brexit strategy.
The UK’s departure from the EU looks set to be arguably the most pressing issue facing the new prime minister. During the leadership hustings Johnson underlined his hard-liner Brexit credentials by pledging to take the UK out of the EU by October 31, while he has consistently supported a UK withdrawal from the EU and campaigned strongly for Brexit during and since the UK’s 2016 referendum.
With markets digesting the latest news, we would expect to see some renewed volatility and uncertainty ahead, as a number of question marks remain over the Brexit terms and negotiations. While we don’t see massive market moves because Johnson was the clear favorite and this outcome was largely priced in, we would expect some increased volatility in sterling and UK government bond (gilt) markets to persist if there is further renewed uncertainty over Brexit or the likelihood of a ‘no-deal’ Brexit persists.
Johnson’s stated commitment to leaving the EU by 31 October could have a slightly weakening effect on sterling, unless he makes some more conciliatory comments on negotiating with the EU. At this stage, this seems unlikely. The new prime minister faces some difficult choices: while not leaving the EU on the set deadline or at all could be politically damaging for him, a ‘no-deal’ Brexit could also be very economically damaging to the UK.
We would also expect to see further market volatility if the EU refuses to renegotiate the existing UK withdrawal agreement. From a currency perspective there is scope for sterling to fall; further, while it has already weakened considerably in recent weeks, it is also possible that we might see sterling revisit some of the lows it hit just after the EU referendum result in 2016 if there is no sign of movement from either side in any further withdrawal negotiations. That said, on many measures sterling appears cheap, so the scope for it to appreciate is probably greater should the new leader succeed in orchestrating an orderly Brexit (or indeed be thwarted in seeking a disorderly Brexit).
Overall, however, we believe that the recent fall in gilt yields owes less to continuing Brexit moves than to wider national and global economic trends. Gilt yields have broadly dropped in line with US Treasury and German bund yields over the last few months, so while the prospect of a ‘hard’ or ‘no-deal’ Brexit may play a small factor in gilt-yield falls, the key drivers are economic: slower global growth, lower inflation and the prospect of more accommodative monetary policy from central banks.
Public Spending to Rise
In wider policy terms, we would expect a Johnson administration to boost public spending and gilt issuance, with Theresa May having already flagged an end to some austerity measures. Some level of contingency for a potential ‘no-deal’ Brexit also seems likely, but we do not expect public spending to rise to the levels we would anticipate under a Jeremy Corbyn-led Labour government.
Beyond government spending, we think the wider UK political picture holds the potential for further surprises. With a divided Parliament and a divided Conservative Party, speculation persists that there may be a vote of no confidence in Johnson’s government with the potential for a snap general election. We think the latter is less likely, but we do see the possibility that Parliament could move quite swiftly to test confidence in Johnson’s administration.
However, while the chances of triggering such a vote are reasonably strong, the scenario of Conservative Members of Parliament bringing down their own government without giving their new leader a chance, looks far less likely.
Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice.
This is a financial promotion. Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Newton Investment Management Limited is authorized and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation. 'Newton' and/or 'Newton Investment Management' brand refers to Newton Investment Management Limited. Newton is registered in England No. 01371973. VAT registration number GB: 577 7181 95. Newton is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton's investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only.
Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including Newton and (iv) representatives of Newton Americas, a Division of BNY Mellon Securities Corporation, U.S. Distributor of Newton Investment Management Limited.
Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2006 The Bank of New York Company, Inc. All rights reserved.