“No deal is better than a bad deal” said Theresa May in a speech outlining the UK Government’s 12 priorities for Brexit on January 18.
The call sets out the Government's stall ahead of what are expected to be tortuous negotiations on a future trade deal with the EU and gives a firm indication that the country will be willing to default to WTO rules when it comes to trading with Europe in the future.
Understandably, there has been significant political opposition to the notion that the UK would be prepared to walk away from Europe should a future trading deal fail to be secured as it could heap massive costs on trade between the continent and the UK.
The currency implications are also notable as it turns out the British Pound might also have an opinion on the matter - and it is not something that those who advocate for a “no deal” would like to hear.
Luca Mezzomo, the Chief Economist at Italian bank Intesa Sanpaolo’s Research Department says the Pound could actually fall to levels below those witnessed in the crash that followed the EU referendum in June 2016 on the event of a no-deal.
In a note to clients dated April 5, Mezzomo says he is actually quite positive on the Pound’s outlook against the Euro and Dollar on the assumption that the UK will ultimately secure a deal with Europe within the two year time frame.
But even on an amicable outcome, “the complexity, uncertainty and duration of the negotiations suggests that risks to the pound will remain skewed to the downside, both this year and the next,” says Mazzomo.
However, Intesa Sanpaolo argue expectations for a recovery of the Pound would “be stumped in the event of the United Kingdom ultimately exiting the EU without an agreement.”
“In this case the Pound would correct, probably dropping below its post-referendum lows against both the Dollar and the Euro,” says Mezzomo.
How Low Could Pound Sterling Go?
While it is nigh on impossible to say where Sterling will end should the UK and EU fail to secure a deal after two years, we can get a good idea of what levels are certain if Mezzomo’s assertion that the Pound will revisit post-referendum lows is correct.
The Pound to Euro exchange rate hit a multi-year post-referendum daily low of 1.1054 in October 2016 according to data provided by the Bank of England.
The Pound to Dollar exchange rate hit a daily low of 1.2133 according to Bank of England data.
And these rates do not account for the flash-crash lows of October 7 as there is no conclusive low given for this event owing to the differing data given by the various exchanges amidst the chaos that was blamed on market malfunction.
Likelihood of ‘No Deal’ is Actually Quite Limited
The general consensus in the markets is that the UK and EU will reach a deal within two years.
Even if the sceptics are right and the two sides fail to reach a deal then there is likely to be some kind of transitional period that could ensure current trading conditions are still in place after two years.
The biggest hint of such an outcome was provided on April 5 when May said there would be an "implementation" phase once an exit deal had been struck, with business and governments needing a "period of time" to adjust to any new restrictions.
May has said she is keen to avoid a cliff-edge in the past but what gives us some certainty concerning the recent comments is May’s confirmation that freedom of movement of EU nationals will in all likelihood be in place during the transition period.
We know that the EU will only consider a transitional period on the basis that the UK continues to allow such freedom to its nationals.
Therefore May is making the right kind of noises when it comes to conceding the conditions required for the transitional period to be implemented.
The view has since been repeated in more explicit fashion by UK Foreign Secretary Boris Johnson who told Reuters on April 6 that his country could allow free movement of people from the European Union during an implementation phase after Brexit to allow the economy to attract talented people.
When asked by Reuters TV if Britain would accept full free movement of people during an implementation phase, Johnson said this was possible, and could be agreed before Britain left the EU in two years' time.
"Ideally I think it could be done, what with goodwill and imagination it could be done as fast as – I think it can be done in two years," says Johnson. "In the last 10 years I have been one of the few British politicians to speak up on the benefits of immigration," he said.
This is the most clear sign yet that the UK will cede to the EU's red-line of freedom of movement of citizens in order to allow an implementation period and we would consider the prospect of a major slump in Sterling to be limited as a result at this juncture.
Pound Forecasts on a Deal
Assuming an agreement is ultimately reached that limits the damage of losing access to the single market – Intesa Sanpaolo continue to expect a gradual recovery of the Pound, towards GBP/USD 1.28-1.32 on a 12m-24m horizon.
“We opt for a modest recovery trend to take into account the risk of tied to the complexity/length of the negotiations – the deadline for which is the end of March 2019 (which coincides with the two-year horizon),” says Mezzomo.
Against the Euro, this would imply an EUR/GBP exchange rate of around 0.86-0.87 on a 12m-24m horizon.
From a GBP into EUR exchange rate perspective this equates to 1.1628-1.1495.
However, there is room for a stronger Pound if the agreement with the EU should prove to be better than expected, or be reached sooner than expected.
“Sterling’s recovery path beyond the near term would be swifter, with a return to pre-referendum exchange rate levels,” says Mezzomo.
The analyst sees GBP/USD above 1.40 and below EUR/GBP 0.80 on such an event.
This is a GBP/EUR exchange rate of above 1.25.