The UK’s economic outlook arguably goes hand in hand with the ongoing process of leaving the European Union. In the context of global economic downturn and monetary easing, the British pound’s trajectory will be subject to a complex combination of political will, monetary and fiscal policies and international trade terms.

The currency’s wide swings are a reflection of a lack of certainties and markets’ indecision. Short-term trades are favoured at the expense of long-term bets. No one wants to get caught in the middle of political and economic upheavals. Here is our forecasts for the British pound under four distinct scenarios in line with economic projections.

Source: Institute for Fiscal Studies

Indefinite delay

Prime Minister Boris Johnson had previously promised to get Britain out of the EU by the end of October “do or die”, but failed to make a breakthrough. The bloc agreed to extend the Brexit date until 31 January 2020. Sounds familiar, doesn’t it?

The deal Mr Johnson had secured with the EU is unlikely to get through Parliament. Markets no longer have illusions after government’s multiple failed attempts, and have adopted a wait-and-see attitude in regards to the pound’s long-term prospect.

Eyes are now on the December election as the Premier makes a last-ditch effort to break the Brexit stalemate with an early ballot. Will the result bring enough supporters for his deal? This is hard to tell as PM’s attempt to end parliamentary paralysis may well turn against him amidst political uncertainties, which would shuffle the cards and open the door to further ramifications.

If the Conservatives keep the power, we would be back to square one unless opposition parties suffer a crushing defeat and pose little threat to PM’s deal. The prolonged delay would keep the UK’s economy subdued as businesses and investors shy away from uncertainties. Growth stays below 1% for the coming year and we may expect the Bank of England to take action and slash the rate, reversing its tightening course from November 2017. On the bright side, the UK will keep all the benefits of unrestricted access to EU markets, effectively providing support to the economy for as long as it is possible.

In this scenario, the pound sterling would stay under pressure and in its current trend of devaluation, though at a moderate pace as this has become the new norm and well-priced-in by market participants.

 

Weekly GBPUSD exchange rate

 

Soft Brexit

Leaving the EU with some sort of a deal seems to be the default option. This is the base scenario that general sentiment has adopted and certainly the reality that markets have priced in for lack of clarity.

Subject to the election result, a Brexit deal will have different flavours. A Conservative win is only decisive if a supportive parliament is by their side. In this case, the deal could be ratified without much hassle, making the withdrawal fairly swift. However, this best case scenario may seem too good to be true in the current political climate. In case of another political stalemate, will the market have enough patience to go through the whole process of negotiation and ratification?

Should Labour emerge victorious, the new government would want to go back to Brussels and renegotiate the terms in favour of a customs union. The party has said to offer in a new referendum the choice between the new deal and remaining in the bloc. While Labour’s agenda e.g. fiscal loosening and tightening of labour market regulations might jitter the markets, we expect the pound to recoup its losses as a softer Brexit unfolds.

Overall, whichever the deal might be, the UK’s economy would reap the benefit due to improved consumer sentiment and business confidence. This could provide cushion against a global slowdown. Growth may return to above 1% with monetary and fiscal stimulus. In light of these implications, a deal could turn the tide and help the pound sterling recover lost ground.

Weekly GBPUSD exchange rate

We expect GBPUSD to break out of the 1.20-1.33 range in a bullish fashion. The correction may attempt to challenge the April 2018 high of 1.43. Depending on the quality of the deal e.g. transitional period or customs union, the rally would have a different reach. A break above 1.43 may trigger an extended rally towards the pre-2016 level of 1.50s.

 

No-deal Brexit

In case the new election fails to seal the deal, a ‘no-deal’ Brexit may remain on the agenda. The UK could immediately break out of the customs union and single market. While the amount of damage on the economy is difficult to quantify, most agree that it is the worst case scenario and its repercussions might be significant.

Under a no-deal Brexit, trade would be conducted on terms set by the World Trade Organization (WTO) before bilateral agreements are negotiated. New tariffs will make UK’s goods and services less competitive while restored border checks could cause further disruption in supply chains.

While unlikely, if the government decides to make it a hard exit by 31 January 2020, a no-deal still needs to get the nod from Parliament. An abrupt divorce could leave a mark on the UK economy and push the pound sterling over an abyss. Depressed consumer and business confidence trigger slump in private consumption and investment. Growth is projected to be near zero with heightened risk of recession. Against a backdrop of global slowdown, the Bank of England has no choice but to cut rates aggressively and implement quantitative easing.

This case would prove to be disastrous for the British pound. Shock no-deal news may bring the currency to its knee with short-term spike to the downside. As the dust settles, accommodative monetary policy and bleak economic outlook are likely to keep the cable underwater for an extended period of time.

 

Weekly GBPUSD exchange rate

We expect GBPUSD to break below the critical support and psychological level of 1.20. A combination of buyers bailing out and fresh sellers joining in may create a bearish spike in a similar fashion to the collapse on the night of the 2016 referendum. That would be a 10-15% vertical drop, especially if markets are caught by surprise. After sporadic pullbacks, the bearish trend may carry the price towards lows not seen since 1985.

No Brexit at all?

Another radical solution would be for the government to scrap the withdrawal all together. A return to 2016 just like waking up from a nightmare and everything, almost, gets back to what it was before. There are two ways to achieve this.

Article 50

While a remote possibility, for now, the UK could reverse the course by revoking Article 50. We would assume this to happen under a new government. Cancelling the withdrawal would be the best scenario economy-wise even though the internal political scene would go under a profound schism. Should this happen, markets are likely to correct sharply and push the pound back towards its pre-2016 level, business as usual at last.

New referendum

Another way to abandon the Brexit is to hold a second referendum and the rank of its advocates have grown significantly lately. The referendum would be advisory and have the same legal status as the one in 2016, and the government would still need to make it legal-binding. A “confirmatory” referendum could be held to choose between a particular deal and remain. The whole point of a new referendum is that it is likely to be in favour of the remainers, probably under a Labour-led government.
Revoking the Brexit may put Britain back to normalisation. Markets would react positively and sharply should there be more substance in this option. We expect the pound to rise back to its 2016 level and leave the whole Brexit drama behind. As volatility settles, exchange rates will be guided once again by monetary policy instead of political tremors.

Weekly GBPUSD exchange rate

We expect GBPUSD to break above 1.33 and 1.43 successively and recover to the pre-Brexit area of 1.50s. Consider it as the Brexit never happened. Should this occur, the question would be how fast the price will surge. A political build-up leading towards the cancellation will manage the spike i.e. the prospect of a remain-biased referendum will certainly generate volatility, but an outright trigger of Article 50 is mostly likely to see the price gap up.