Brewin Dolphin Insight: Parliament requests Brexit extension

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Unable to secure a deal in the agreed timetable, the government will ask the EU for a temporary delay to Brexit. In this Insight, we look at what it might mean for the markets and investments.

After three days of high political drama, last night MPs voted in favour of delaying Brexit beyond March 29.

The result, with 412 in favour and 202 against, wasn’t a surprise given that the House of Commons had voted the previous evening to reject a no-deal Brexit under any circumstances. The day before that, MPs had rebuffed Theresa May’s Brexit deal for a second time by 149 votes – the fourth biggest government defeat in Commons history.

A delay to Brexit day now seems highly likely. But it is important to note that this relies on the EU agreeing to the request. Further, this week’s vote against no deal was not  egally binding. Until an extension to Brexit is requested and approved by the EU, the UK could still leave the European Union at 11pm on March 29 without
a deal. The uncertainty is far from over.

What happens next?
The prime minister has decided to hold a third vote on her Brexit plan next week, just days before she is due to attend an EU summit in Brussels. That may seem a fool’s errand given the size of the defeats the deal has suffered already. However, its passage is not impossible.

Mrs May is hoping that by reconsidering the legal position on the Irish backstop she will win over Tory MPs and the Democratic Unionist Party who have previously voted against her deal. This was made more likely by
Wednesday night’s votes which effectively removed the option of leaving without a deal. Even so, some particularly hard-line Eurosceptic Conservative MPs are believed to be determined not to vote for the deal.

That makes the maths of passing this bill very difficult and probably requires more abstentions from Labour in order to be decisive.
The prime minister has also sought to impress on Eurosceptic critics that unless they back her deal they could be forced to accept a long Brexit delay. MPs voted last night in favour of delaying Brexit day until June 30.

But the prime minister said on Wednesday that if a deal was not agreed by MPs before the March 21 EU summit, she would be forced to seek a “much longer extension”. The prime minister added that this would “undoubtedly require” the UK to hold European Parliament elections in May, something that Brexiteers are keen to avoid.

However, legal opinion is divided over whether such elections would have to take place on 23-26 May 2019. What is clear is that to implement an extension the UK government will need to legislate to change the EU Withdrawal Act which sets the date of Brexit as 29 March 2019. Any extension to Article 50 also needs to be agreed by all member states in the European Council.

Given the justified concerns about the economic and political fallout should the UK exit without a deal, EU leaders will probably support an extension. Donald Tusk, the European Council president, has urged EU leaders to be open to a “long extension” of the Brexit deadline to allow parliament more time to determine its stance on leaving the bloc.

However, the UK will still be required to show a “credible justification” for a possible extension and its duration.

What might a “credible justification” look like?

If Theresa May’s deal is rejected for a third time next week, the government could propose to negotiate a completely new Brexit deal. Some MPs have been calling for parliament to hold a series of indicative votes on a variety of Brexit options. The aim would be to determine which option has the greatest support in parliament, but it might still fail to break the deadlock. More than one option might command support of the majority of the House. It is also possible that no one option would gain a majority among MPs.

Also, the EU is only likely to agree to go back to the drawing board if the UK pivots towards a closer relationship with the EU than the current deal proposes. That would set up another battle with Tory Eurosceptics unwilling to accept a softer Brexit approach.

If it isn’t possible to negotiate a better deal, the delay to Brexit could also revitalise calls for a second referendum, though another vote would take time to organise. Experts at University College London’s Constitution Union have suggested that the minimum time needed to hold a referendum would be 22 weeks.

That would raise the question, again, of whether the UK will need to hold European Parliament elections. If the UK and EU can’t reach an agreement during the extension period a no-deal Brexit would remain the default option (unless we agree to unilaterally withdraw Article 50 or agree a second extension with the EU).

Although the votes in parliament have made a no-deal Brexit less likely, the difficulty of securing parliamentary approval means it remains a possibility.

What does this mean for the markets?
All that asking for an extension has done is prolong the uncertainty: very little has changed. The economic backdrop to this week’s vote is, in a word, mixed.
Economic activity is relatively robust and unemployment is low. However, the savings rate has been falling and there has been an unwillingness to invest without clarity over where the Brexit process is heading. Now that we have agreed on requesting an extension, that picture hasn’t changed.

The decision to quit the EU has demonstrably caused Brexit-phobic international investors to shun UK assets. As the extension prolongs the uncertainty, both foreign direct investment and domestic investment are likely to remain subdued.

What happens next will affect how we react to events in the short term. If Mrs May can craft an agreement which satisfies a majority in parliament the pound is very likely to rally, though perhaps not by as much as some might expect. We currently estimate that the financial undervaluation of sterling is only around 5%.

Yet even a modest sterling rally could provide a boost to UK equities. A decision to hold a second referendum may also offer strength which we can sell into, even if the likely result of such a referendum is extremely uncertain.

If a deal can’t be agreed and the UK looks likely to leave the EU without a deal at the end of the extension, we
would expect to see a strong sterling sell-off. But that won’t necessarily be bad news for the UK stock market,
as UK company revenues are heavily dependent on overseas earnings. When sterling weakens, revenues
from overseas markets are worth more once converted back into sterling.

What should I do now?
Despite the continued uncertainty, overall the UK stock market backdrop looks reasonably benign. This year we have already seen a better trading performance from UK equities than at the end of 2018, partly reflecting the fact that some of the worst fears about the impact of Brexit on the UK economy now look unlikely to be realised.

It is important to keep Brexit in perspective. For international investors there are bigger issues at stake.

Global growth has slowed markedly in recent months and there remain plenty of potential sparks for further volatility in the year ahead, from Italian banks to President Trump’s unpredictability. But we think global growth would have to grow much worse before cash or bonds look more attractive than equities.

Heightened turbulence – be it the result of Brexit or other macroeconomic factors – can be unnerving but can also offer the chance to pick up quality stocks, or add to existing positions, at more attractive valuations. Currently, valuation anomalies in the UK stock market are not dramatic, but we remain alert to new opportunities that could arise from a pick-up in volatility.

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