Forget a second referendum, the only outcome that could see the pound rally from here is Brexit happening with a deal
I would like to take a moment challenging what has mistakenly become received currency “wisdom”. The myth I wish to debunk is that the rally seen in sterling is the result of a growing expectation that we will have not merely an extension in the Brexit process, but its entire subversion through a second referendum. Those supporting this view have identified sterling’s comparative rally in recent days to a twenty month high against the euro as evidence that foreign exchange markets are pricing “away” a “meaningful” Brexit.
Now, the reasoning behind this – mistaken – received wisdom seems simple enough. Surely, anything that forestalls the UK’s formal exit from the EU should return the pound to where it fell from in the aftermath of the shock vote to Leave. Put differently, with Brexit in effect abandoned the pound’s value should return to the status quo, ante bellum or “what existed before the infernal war”.
From my perspective, those who maintain the pound will respond positively from anything that subverted Brexit are ignoring the considerable internecine tensions that exist within the two main political parties, tensions that would almost certainly come to an even more divisive head in such an event. Between them the staunch leavers within Tory ranks, and the combined Labour and Conservative MP’s representing Leave constituencies, are consequential in their numbers.
For these parliamentarians – and indeed many of the DUP’s MPs and one former Lib Democrat who has given up the party whip – a no-go Brexit would leave them exposed to the opprobrium of their constituency party and their constituents. The brinkmanship we have seen is doing a great deal to focus the minds of this parliamentary “majority”. Focus so much, in fact, that this group is growing ever more likely to vote for a deal close to the one May proposed, and was so meaningfully voted down, on January 15th. To reinforce my confidence that we are close to the denouement of Brexit happening, let me consider the path which the UK would go down otherwise.
There are numerous imponderables involving any General Election that would follow a Brexit delay and resulting certain political party proliferation. For one there is the question of how the SNP would do in such a contest, ridden as it is now with its own internal divisions. There is also the question of what path Ruth Davidson MSP might take her Scottish Tory MPs, and so too the issue of “which” Conservative Party the DUP would volunteer its support to. From my perspective, the answers are simple enough. The SNP would perform even more indifferently than in 2017. For her part, Ruth Davidson could add to the split in the Conservative vote, by distinguishing the Scottish Conservative Party as practically a separate entity. As for the DUP, I am confident it would supply its votes to what I have titled the “True Tory” Party – e.g. the ERG – which would certainly split from the Continuity (wet) Conservatives. Just as the Conservative Party would split so the Labour Party would do all the more than we have seen. There would be the “Loyal” Labour Party sticking to Corbyn and the “New, New” Labour Party rallying around any one of a dozen names who would throw their hat into the leadership ring.
Whatever their avowed differences in all other areas of policy, those fighting under the banners of “True Tory” (think here of Jacob Rees-Mogg) and “Loyal Labour” (think here Dennis Skinner) would be sure to do so on manifestos promising to honour the UK’s referendum of 2016 (making no room for a revived UKIP). For their parts the “New, New” Labour, “Continuity” Conservatives and Liberal Democrat Parties, would all be fighting for the same centrist ground, all promising a second referendum.
Now were I asked to predict parliamentary representation in such a proliferated party world, I would answer that it would make for very unstable coalition government, with the centralist vote split between three, possibly four, parties, whose leaders competitively vied to be the centrist. As for what would happen to those constituencies that in 2016 voted with a majority to Leave, I believe a great many would be successfully contested by the “True Tory” and “Loyal Labour” parties. It is here then that I return to the direction sterling would take were Brexit kicked into the long grass. The pound would hardly fare well against the backdrop of fraught political alliances and UK General Elections seemingly being only a short coalition collapse away.
With all the above in mind the reality is that the only outcome that could see the pound rally from here is Brexit happening with a deal, and one delivered without any “meaningful” delay. And I remain convinced this is precisely what we will have and what is in fact being ever more priced-in by currency markets.
Dr Savvas Savouri is chief economist at Toscafund