GBP: 60% Chance of 'No Deal' Bodes for Deep Declines Forecast MUFG

Brexit and the Pound

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- MUFG say 'no deal' odds at 60%

- Most 'bearish' major forecaster on Sterling

- "We now consider leaving the EU without a deal as the most likely scenario"

- Lower forecasts as a result

Pound Sterling is set to lose a further 3.0% of its value against the Euro and nearly a further 9.0% of its value against the U.S. Dollar by the time 2019 is out say foreign exchange analysts at global investment bank MUFG.

The Japan-based multinational says Sterling is likely to suffer substantial further declines over coming months as they attach a 60% chance of a 'no deal' Brexit taking place.

This is significant as the majority of institutional currency analysts and economists maintain the a base-case view that a last-minute deal is struck between the EU and UK, which should ultimately provide support to Sterling.

In fact, a poll of over 50 of the world's leading institutional analysts shows MUFG to be the most pessimistic of the bunch for both GBP/EUR and GBP/USD forecasts on a six-month horizon.

"Heightened Brexit uncertainty and the ongoing slowdown in global growth have increased downside risks for the UK economy heading into the second half of this year. We now believe that a No Deal Brexit is more likely than not, and it could tip the UK economy into recession," says Derek Halpenny, Head of Research at MUFG.

There is now a 60% chance of a 'no deal' Brexit say MUFG, this compares to the 40% chance odds seen by betting markets and the wider financial market.

A Reuters poll of economists has shown a 5% rise in expectations for a 'no deal' Brexit over the last month, with results from the August poll showing 35% of economists interviewed think a ‘no-deal’ will happen compared to only 30% in the July poll.

The rise in probabilities corresponds with a 2.82% fall in the GBP/EUR exchange rate and 3.53% fall in the GBP/USD exchange rate over this time period.

The British Pound has fallen 5.26% against the U.S. Dollar and 3.11% against the Euro thus far in 2019 with declines accelerating in May as markets started to ramp up bets that the UK would leave the EU without a transition deal.

"As the political risk premium rose, GBP was the worst-performing G10 currency in each of May, June and July, but the negative risk premium can still rise further," says Adam Cole, a foreign exchange strategist with RBC Capital Markets.

Chances of an election and no deal

The striking takeaway from the market's judgement for a 'no deal' Brexit is that probabilities for a 'no deal' can go materially higher, and therefore the potential for further Sterling declines is sizeable.

In short, the market still favours an eventual agreement between the EU and UK being found and there might come a time when that assessment tips into an outright belief that a 'no deal' will transpire

This assumption appears to be driving the forecasts at MUFG.

"The UK has set to conditions for negotiations – to agree to reopen the Withdrawal Agreement for re-negotiation and to scrap the backstop. European leaders have consistently stated that the Withdrawal Agreement and the backstop in it cannot now be changed. We are heading for a major showdown that will likely involve some degree of constitutional crisis, financial volatility and probably a general election," says Halpenny.

As we move through mid-August there remains little movement from both the EU and UK to work towards a solution.

Indeed, news headlines out over the past 24 hours suggest Prime Minister Boris Johnson believes the EU will 'blink' at the last minute, while the EU are reportedly awaiting 'retainer' MPs in Parliament to move the UK away from a 'no deal' scenario.

A government source told the Guardian Johnson's team are not expecting any breakthrough with the EU until Brussels had seen what happens in the first weeks of September, as the parliamentary battle plays out.

According to MUFG, there are three scenarios that might play out over coming months:

1) The EU and the UK meet and negotiate.

"In this scenario, say Ireland decides to water down its demand on the backstop, the UK agree and an adjusted deal is reached and the UK leaves on 31st October into a transition while a trade deal is negotiated. We don’t give this scenario much hope," says Halpenny.

2) PM Johnson pursues a no-deal Brexit.

3) Parliament thwarts 'no deal

"We now consider leaving the EU without a deal as the most likely scenario and hence have lowered our GBP forecast levels accordingly," says Halpenny.

MUFG expect some GBP recovery in 2020 based on measures taken through restarted negotiations to ease the negative impact and based on the assumption of fiscal stimulus implemented to counter the economic impact in the UK.



The Pound-to-Euro exchange rate is forecast to end 2019 at 1.03, the Pound-to-Dollar exchange rate is forecast to end the year at 1.1030.

This suggests a 3.0% decline in Sterling against the Euro from current levels around 1.0771 and a sizeable near-9.0% decline against the U.S. Dollar from current levels at 1.2080.

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