Forecasting Brexit has gone from hard-to-impossible. The fluid, politically charged situation means scenarios changes with the news cycle. Times like this we would just like some popcorn to watch the action from the sidelines. It looks like the UK is heading for another useless extension. One thing is for sure, for the UK's economic outlook, extra uncertainty will further damage economic growth and investor appetite. Tuesdays, construction PMI data which fell to 45 against 46.5 expected, highlighted the harm prolonged ambiguity is having on activity. Today, services PMI dropped to 50.6 in August, from 51.4 in July. Fall in service PMI indicates that the critical services sector of the economy is just holding on.
Given the number of Tories rebelling today's anti no-deal Brexit legislation is likely to succeed. PM Johnson has indicated that he would not go back to Brussels to ask for another extension. Now PM Johnson indicated that he would push for a general election under the Fixed-term Parliaments Act but Leader of the Opposition, Jeremy Corbyn stated labor would not lend vital votes for a general election until another Article 50 extension had been secured. Despite the noise, the probability of a no-deal exit remains the highest outcome in our view.
In this scenario, we would expect the BoE to jump into action to stabilize the economy with significant interest rate cuts. Inflation has crossed the 2% threshold. Yet inflation remains transitory as decline the pound has increased inflationary pressure in the UK, mainly because it has raised the cost of imports. Core inflations that climbed to a six month high of 1.9% will not keep BoE from cutting. Yields on 10yr gilts fell to record low at 0.382%, on news of a potential early election. In usual times, surging inflation would cause the central bank to tighten monetary policy, via the benchmark interest rate. This would further pressure the UK yield curve and drive GBP lower. Worry about overcrowding in GBP is unfounded as short positioning in the past has been greater. No-Deal Brexit is mostly but not fully priced into. The further downside in GBP against CHF and JPY looks likely given the political uncertainty market is facing this critical week..
By Peter Rosenstreich