As the country goes tumbling towards a parliamentary vote on Theresa May’s Brexit withdrawal agreement, one thing is clear: this will not be easy. The government’s official line is there is only one meaningful vote, and simple mathematics leaves us assuming the deal as it stands will not pass, but some commentators are now arguing that this pessimism is misplaced.
There are a few reasons for this. One seems to stem from the psychological impact that MPs would suddenly realise the sub-optimal options of “no deal” and “no Brexit” and back a deal. But speculation has grown that the May team could be rescued by something else – a negative reaction from financial markets, which would spook MPs into backing the Brexit deal, if given a second chance (as some in Westminster believe they will be). A theory worth investigating.
The strategy certainly has form. In October 2008, the beginning of the global financial crisis, the US Congress rejected a deal known as the Troubled Asset Relief Program, or Tarp, which allowed the US Treasury to buy up bad loans from banks and provide support to the country’s banking system. Once rejected, investors around the world went into panic selling. Stock markets plummeted. This helped convince Congress the programme was necessary at a second vote.
Could something similar happen in the UK over Brexit? I’m not so sure, and there are a few reasons why.
The barometer for global financial markets and investors’ sentiment towards Brexit has actually been the strength (or lack of it) of sterling and the wider currency markets, not stock markets. Both foreign and domestic investors have been worried over the uncertainty and economic impact of Brexit on the UK economy, so they have sold sterling-priced assets and bought elsewhere, which has in turn sent the value of sterling down.
We have witnessed this since the moment David Cameron announced the referendum. The value of sterling against major currencies such as the dollar and euro has generally fallen, but it has also regained back some of these losses whenever some form of positive news or certainty over future trade relations has come to the fore. We all remember the sharp drop in the value of the pound moments after the referendum result became clear in the early hours of 24 June 2016, but on Thursday, following the leaked draft agreement with the EU, the value of sterling rose.
The government may be hoping for something akin to the fall in sterling seen on referendum day if Parliament votes down the deal. This has the potential to cause panic among MPs and constituents, and secure support for a second vote. But such an expectation, which relies on the public’s general lack of understanding of financial markets, is naive.
The reason for this is that sterling has an inverse correlation with the UK’s main stock market. This means that as sterling decreases in value, the value of the FTSE 100 index, the country’s largest companies, goes up. This is because the FTSE 100 is comprised of multinational businesses, which collectively generate most of their revenues from abroad. As sterling goes down, these revenues rise in value making the companies more profitable. Given the stock market is generally, but incorrectly, used by the public as a barometer for how financial markets receive news, it might not go as badly as the government hope. In the immediate aftermath of the Brexit vote, then-Ukip leader Nigel Farage cited the soaring FTSE100 as evidence that Remainers were “scaremongering”.
Second, for the government to hope for a similar reaction to the Tarp deal shows a lack of understanding of how markets react to news.
The impact on sterling seen since the referendum was announced is not necessarily based on Brexit being bad for the UK economy. Most may think it’s bad, but not catastrophic. But investors have simply been unwilling to withstand the uncertainty it causes. There is always risk inherent within uncertainty which is something most investors are not willing to take, especially when they can turn elsewhere to make money. To compare this with the imminent collapse of the US, and thus global, financial system is somewhat far-fetched. The worst-case scenario of no deal Brexit will still leave the country functioning bar short-term disruption, and markets know this. That’s not to say they think it’s a good idea; it’s just not terminal.
Investors will be looking for any sniff of information about the government’s plans to make sure they’re best placed. Markets are not impervious to news, they thrive off it. Should there be a high probability for a second parliamentary vote, markets will not unnecessarily react negatively to a loss in the first, but simply wait for the second to see what happens. The government relying on markets to do what they need has all but guaranteed it will not work.
Taha Lokhandwala is a journalist who writes about investing, markets and personal finance for Investors Chronicle. Follow him @ICTaha
Content from our partners
Related
