The U.S. isn’t the only country to be paralyzed by political division. Across the pond, Britain is edging closer toward leaving the European Union (EU) without anything resembling a clear action plan.
At the beginning of 2019, the British Parliament rejected Prime Minister Theresa May’s proposed Brexit deal by 230 votes. May’s setback, the greatest defeat in the country’s democratic history, has suddenly left the U.K. in a deadlock with just little over two months to spare until it is scheduled to leave the EU.
At this late stage, all options are back on the table, including a Brexit without a trade deal or the whole thing being scrapped entirely. Goldman Sachs says there's a 50% chance of a later, softer Brexit. The brokerage assigned a a 40% probability to a reversal of Brexit via a second referendum or general election and a 10% probability to a “no deal” Brexit.
Here is a breakdown of all the different terms being thrown around — and how each of them could impact investors and the economy.
Since the U.K. public voted to leave the EU in June 2016 and Prime Minister May submitted the Article 50 withdrawal notification in March 2017, talk has centered on whether the U.K. should pursue a “soft” or “hard” Brexit — terms used to refer to the closeness of the country’s relationship with its key trading partner once their divorce is cemented.
A hard Brexit is another way to say a clean break from Europe. That means Britain giving up membership of the EU's single market, an arrangement that enables the country to trade freely with its European partners without restrictions of tariffs.
Supporters of a hard Brexit want the freedom to set up their own trade deals and rules. The problem is that drawing up its own independent trade agreements will take a lot of time and, in the meanwhile, force the country to use less favorable World Trade Organization rules.
If Britain finds itself outside of the customs union, imported goods will suddenly become much more expensive, squeezing consumer spending across the country and weighing on the many firms that buy in European materials and do business with their European partners. At present, roughly 45% of the U.K.'s exports are to the EU while 50% of the goods it imports come from the EU.
"Should the U.K. go down the hard Brexit path, the U.K. economy would likely slow further as EU trade uncertainty weighs on consumer sentiment and business investment," said John Lynch, chief investment strategist at LPL Financial
If British politicians fail to come to an agreement before the U.K. is scheduled to leave the EU March 29, 2019, the country will walk away with no deal.
Unlike, a hard Brexit, which could theoretically include some type of agreement with the EU and potentially set out a transitional period to negotiate free trade deals, a no deal scenario presents no cushion whatsoever.
Economists across the world have repeatedly warned against a hard Brexit. When they discuss a no deal scenario, their predictions are even more catastrophic
The Bank of England warned that a no deal Brexit could shrink the U.K. economy by 8% in a year and lead domestic house prices to fall by a third. British and European stock markets will certainly be punished, as will the U.K. currency.
The rest of the world’s economy is expected to get caught up in this chaos, too. Recently, the International Monetary Fund became the latest big name to warn that a no deal risks triggering a further slowdown in global growth.
"The U.K. constitutes only about 2% of the global economy and 4% of world goods trade, so global ramifications of all realistic scenarios are likely to be manageable," said Lynch. Capital Economics has warned that a disorderly exit could hurt British GDP growth by 1–2% spread over two years.
In general, economists agree that the least damaging path would involve what the media have been calling "soft" Brexit. This term is used to refer to Britain remaining closely aligned to the EU by retaining some form of the bloc’s single market.
Such a scenario would minimize disruption to trade, supply chains and businesses in general. However, there is a major sticking point: the EU has demanded that access to the single market can only be granted if all its principles, including the free movement of people, are respected.
Supporters of a soft Brexit have called for a deal similar to what Norway has with the EU. Norway is a member of the single market, but in return abides by the free movement rules. It’s already become clear that many U.K. politicians aren’t willing to compromise on immigration, claiming that such a deal would betray the wishes of the British public.
“We expect UK domestic stocks to outperform UK exporters by 20% if a soft Brexit materializes,” said Sebastian Raedler, head of European equity strategy at Deutsche Bank, in an interview with Bloomberg.
Brexit on Hold
If the U.K. wants to avoid crashing out of the EU without a deal, Article 50 will almost certainly have to be extended. The March 29 expiry date is quickly approaching, meaning that there is little time left to renegotiate any type of new agreement.
Whether the EU will agree to extend the deadline is unclear. Most of the bloc’s states agree that it is in their best interest to prevent a hard Brexit, although it is also true that they are growing frustrated and appear to be losing hope that a deal that suits all parties can be agreed on.
British politicians are divided on what Brexit they want and finding a way to match all their requests, together with those of the EU, increasingly appears to be an insurmountable challenge. Dragging on the process another two years without any guarantees of finding a breakthrough might scupper chances of a serious renegotiation ever getting off the ground.
That said, the recent appreciation of the U.K. currency suggests that traders are confident that Brexit will be put on hold for now. Sterling, and the ETFs such as Invesco CurrencyShares British Pound Sterling (FXB), VelocityShares Daily 4x Long GBP vs USD ETN (UGBP) and ETFS Short NZD Long GBP (NZGB.L) that track its movement, have been rising, implying that investors are hopeful that a damaging no deal Brexit can be averted.
Placing Brexit on hold would ease fears that the U.K. will leave the EU without a deal. However, uncertainty would still remain over whether Britain will eventually secure a hard or soft Brexit agreement, or call a second referendum that could see the decision to leave completely revoked.
That would ultimately mean further volatility as investors continue to try to second guess how Brexit will play out and how the many companies caught in the crossfire will fare under each potential scenario. Meanwhile, these same firms will undoubtedly be impacted by being left in the dark about future relations with a key trading partner.
Goldman Sachs has said that continued Brexit uncertainty, such as an extension of the March 29 deadline, "could pose risks" to U.K.-facing U.S. stocks like Newmont Mining Corp. (NEM) and Invesco Ltd. (IVZ).