Brexit talks: the moment of truth
A new round of post-Brexit trade negotiations has started between the UK and the EU. We continue to think a narrow, ‘bare bonds’ trade deal may emerge before the end-year deadline, and has the potential to cover trade in services as well as goods. But it remains that exit from the EU’s ‘Single Market’ will impact the UK’s productivity and growth in the longer run.
In addition, the risk remains high we have ‘no deal’ (we put the probability at around 40%). Failure to reach a deal by deadline would harm 2021 growth in the UK, but various measures taken to avoid a ‘black hole’ effect on 1 January could limit the impact. Much would depend on the impact on business and consumer confidence. We note that the EU has already authorised the operation of the UK’s clearing houses post-1 January 2021, which would lessen the risk of disruption in the case of ‘no deal’. In the longer run, a bare bones trade deal is likely to be upgraded subsequently and in time the UK might join the European Free Trade Association.
Meanwhile, the news is not good on the pandemic front for the UK economy, not helped by the government’s hesitancy to extend fiscal support. We continue to think the Bank of England will increase quantitative easing (likely in the fourth quarter), but we think we will only see negative rates in the case of a messy no-deal conclusion to trade talks with the EU.
A very basic trade agreement could leave the 10-year gilt yield at 0.1% at the end of this year. In the case of a fuller deal (increasingly expected by bond market participants), the yield could creep up to 0.4%, but fall towards -0.2% in the case of no deal. After sterling’s recent decline, further downside potential is limited, in our view. However, we do not expect any significant out performance by sterling should a ‘bare bones’ deal be reached.