Weekend press point to high risk UK Brexit strategy, market negative – Deutsche Bank

Oliver Harvey, Macro Strategist at Deutsche Bank, notes that the major UK Sunday newspapers report today that Tuesday’s Brexit speech by PM Theresa May will used to outline an uncompromising position including full control over immigration, sovereignty from ECJ decision-making and preparedness to exit the customs union.

Key Quotes

“In an article for the Sunday Times, Brexit minister David Davis made clear that negotiating third-country free trade deals, difficult under continued customs union membership, would be a top priority. Davis also pointed to a transitional deal to smooth the UK’s exit, in line with recent rhetoric. Taken together, the reports represent a high-risk strategy for the UK’s initial negotiating stance and, in our view, are consistent with the market beginning to fully price a hard Brexit.”

“Most important is the Prime Minister’s reported willingness to forgo membership of the customs union. As has been well documented, a full exit from the customs union would be highly economically disruptive and would compromise investment in major UK export sectors such as autos.”

“Leaving the customs union would leave the UK a free hand to negotiate third-country trade deals, such as with China or the US. We are not optimistic, however, that third country deals could replace the UK’s existing trade arrangements soon. Trade deals are highly complex and it would be highly challenging to negotiate them under the current political timetable. The benefits of seeking third-country deals are also questionable given increasing evidence of protectionism and slowing global trade.”

“The reported hard-line stance is also likely to increase domestic political instability, with many MPs concerned that Single Market Access should be the highest priority for negotiations. It should also raise tensions with the Scottish government, with SNP leader Nicola Sturgeon having pledged her support for a second independence referendum if Scotland does not remain in the Single Market.”

“In terms of market implications we see press reports as a material negative should they prove accurate and a catalyst for the market beginning to price hard Brexit. We see a deterioration in political rhetoric around Brexit as a key catalyst for further sterling weakness and see the large terms of trade shock from full exit from the Single Market consistent with GBP/USD at 1.06 or EUR/GBP close to parity respectively.”