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You Say You Want to Leave the Union…?

Uncertainties over the UK’s plans to leave the European Union has generally stirred unease across global financial markets, central bank monetary policies, as well as economic growth prospects.

Recent analyses of several European and international corporate sectors and commodities, including retailers, auto and telecommunications companies, as well as prices of gold and crude oil, all point to Brexit as a major catalyst.

The UK’s deadline to depart from the EU is scheduled for March 29, 2019, which is merely 30 calendar days away.

Over the course of several domestic political disputes over how the UK should construct its exit, a long list of central banks, as well as the International Monetary Fund (IMF), have highlighted the near-term event as worrisome to economic growth.

The Bank of Korea, for example, said Thursday that the pace of global economic growth has continued to slow “somewhat,” affected by factors such as trade protectionism, the paces of monetary policy normalization in major countries, and uncertainties over Brexit.

Brazil’s central bank also said at its monetary policy meeting earlier in February that the global outlook “remains challenging,” amid headwinds such as trade conflicts and Brexit.

In January, the International Monetary Fund had cut its global growth outlook from its assessment in October 2018, amid risks that have tilted to the downside, including U.S.-China trade-related tariff effects, a “no-deal” withdrawal of the UK from the EU, and a greater-than-expected slowdown in China.

According to the IMF’s World Economic Outlook, growth in the Euro Area is set to moderate from 1.8% in 2018 to 1.6% in 2019 (0.3 lower than anticipated last fall) and 1.7% in 2020. The WEO stated that growth rates have been “marked down for many economies, notably Germany (due to soft private consumption, weak industrial production following the introduction of revised auto emission standards, and subdued foreign demand).”

Meanwhile, U.S. Federal Reserve Bank chair Jerome Powell reinforced in his latest congressional testimony that the Federal Open Market Committee’s (FOMC) decision in January to take a ‘patient’ approach was, among other global concerns, spurred by elevated uncertainty around “several unresolved government policy issues, including Brexit and ongoing trade negotiations.”

In the UK, the Bank of England’s Monetary Policy Committee (MPC) generally has its hands tied, as political frenzy over Brexit continues to play out.

The Bank of England has said that the economic outlook will continue to “depend significantly on the nature of EU withdrawal, in particular: the new trading arrangements between the European Union and the United Kingdom; whether the transition to them is abrupt or smooth; and how households, businesses and financial markets respond.”

The MPC added that the “appropriate path of monetary policy will depend on the balance of these effects on demand, supply and the exchange rate. The monetary policy response to Brexit, whatever form it takes, will not be automatic and could be in either direction.”

At its meeting earlier in February, the MPC voted unanimously to maintain Bank Rate at 0.75%.

Brexit uncertainties have also generally thrown a wet blanket over consumers’ appetite for spending.

Joe Staton, GfK’s client strategy director, recently attributed concerns over UK household finances, the general economy and purchase intentions, to political uncertainties over the Brexit outcome.

Elsewhere, British Retail Consortium chief executive Helen Dickinson had stressed in October 2018 that securing a clearly defined deal with the EU is critical in providing certainty and protection to UK consumers. She warned that any delays caused by increased red tape will pose a serious impact on over one-third of UK food imports, pointing to the government’s recent technical notices as evidence a No-Deal Brexit is likely to spur reduced availability and higher prices of food and medicine.

EU Secretary of State Dominic Raab recently said that in the event of a ‘No-Deal’ exit, “practical measures” have been set out to mitigate any risks of supply disruption.

Some UK food retailers apparently have already begun preparations for downside scenarios.

In recent activity, the UK and EU have been hammering out an annex to their agreement for withdrawal, which is likely to be in place in the very near-term, as well as permit a new vote by March 12.

A rejection of the bill will result in a next-day vote on a no-deal Brexit, which some MPs view as preferable to the Withdrawal Bill.  However, If this is rejected, then there will be a vote on a formal extension of Article 50 of the Lisbon Treaty – a basic plan for the departure of an EU member state from the Union.

A formal extension or a Withdrawal Agreement is set to be finalized at the EU Summit, scheduled for March 21-22 – one week prior to the March 29 deadline.

Still, it doesn’t appear as if the British government has banded together on any best effort exit execution.

Labour leader Jeremy Corbyn reportedly said Thursday he would support another EU referendum following the defeat of his alternative Brexit plan in the House of Commons. However, he is also said to be continuing his fight for other available options, including a general election.

Marc Chandler, chief market strategist at Bannockburn Global Forex, noted that in some ways, “Corbyn’s formal acceptance of the party’s plank calling for a second referendum played into May’s hands.

“May implied that a second referendum was a Trojan Horse with the Remain Camp hidden inside, ready to overturn the 2016 results. The risk that defeat could be snatched from the jaws of victory that was a month away now is forcing even some of the most virulent Leavers to pause.

He added that perhaps “one of the most successful tactics of the Prime Minister was to shift the brink from a no-deal exit to no exit.”

UK Prime Minister Theresa May has had to make a series of concessions for MPs to back her Brexit strategy and faced a Brexiteer rebellion, where 20 Tory MPs reportedly slammed proposals to delay the March 29 deadline in the event of a no-deal scenario.

UK agriculture minister George Eustice resigned his post apparently in protest over the decision to permit MPs to delay Brexit by extending Article 50.

However, despite the discord, the market’s perception about the UK’s credit profile seems to wax confident about the government’s ability to honor its debt obligations in the medium-term.

Spreads on the country’s five-year credit default swaps (CDS) were quoted at a little more than 36bps intraday Thursday, around 6.7bps tighter than where they stood towards the end of December 2018. Over the past three months, spreads have even narrowed by around 0.5bps.

Major financial firms, including Lloyds Bank, HSBC and Standard Chartered have also seen their five-year CDS spreads tighten anywhere from 15bps to 26bps over the past three months.

Although equity holders experienced a downturn of roughly 23.35% in the iShares MSCI UK ETF since May 2018, they have recovered about 14% from their latest 52-week low set December 24.

Among the data due out in on the UK’s economic calendar in the week ahead, investors will receive:

Monday, March 4: Construction PMI (Feb)

Tuesday, March 5: Markit/CIPS UK Services PMI (Feb)

Thursday, March 7: Halifax House Price Index (HPI) – Feb

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Steven Levine

Steven Levine is a Senior Market Analyst at Interactive Brokers, (IBKR), which provides online trade execution and clearing services to institutional, professional and individual investors for a wide variety of electronically traded products including stocks, options, futures, forex, bonds, CFDs and funds worldwide.

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