Having seemingly out-manoeuvred her Brexiteer colleagues with agreement on a ‘soft Brexit’ approach at Chequers last Friday (6 Jul), prime minister Theresa May is now reeling from the resignation of her Brexit secretary David Davis and foreign secretary Boris Johnson in the space of 24 hours.

The latter news is having the greater market impact which is unsurprising. It was arguably the decision of Boris Johnson to back Brexit which first led the markets to take seriously the prospect of the UK exiting Europe back in February 2016.

Johnson’s latest move, which some expect to presage a leadership challenge, led to a big fall in the value of the pound. There now seem to be three likely scenarios as Brexit negotiations with the EU reach their crunch point ahead of the UK’s scheduled departure in March 2019.

1. Theresa May hangs on and gets a version of her Chequers agreement through the UK parliament

This scenario would almost certainly be positive for sterling and the more domestic-focused mid cap FTSE 250 index. It might also increase the chances of an interest rate hike soon. Currency movements could act as a drag on the FTSE 100.

Investment bank UBS rates this as the most likely outcome. ‘The prime minister seems to have broken the deadlock at home with the cabinet agreement on the direction of Brexit. It hasn’t been cost free as two cabinet ministers have resigned from government.

‘Speculation around further resignations and the potential for a leadership challenge will no doubt ensue. Our expectation is that the prime minister will survive this and push ahead with her vision for Brexit.’

2. May is unseated by Boris Johnson or another candidate who pursues a hard Brexit approach

This should see the pound fall, at least in the short-term, as it would increase the chances of a ‘no-deal’ Brexit. This might ultimately be positive for the FTSE 100 given its inverse correlation to sterling and the international nature of its constituents.

The challenge for Johnson or A.N. Other is there does not appear to be sufficient support in Parliament for a ‘hard Brexit’.

3. The political turmoil leads to a general election even a second referendum on EU membership

Theresa May has warned that divided cabinets lose elections, raising the prospect of Jeremy Corbyn’s Labour Party taking office. The left-wing agenda of such a government would be expected to create fear in the markets.

A second referendum which saw voters agree to reverse Brexit might be positive for the economy in the short-term but would likely raise as many questions as it would answers. (TS)

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