22 March 2019
Article 50 extended: Is a ‘no deal’ Brexit now more likely?

EU leaders have granted an extension to the Article 50 negotiating period, piling the pressure on the UK Parliament to agree a way forward on Brexit. The question is: will a majority of British MPs settle on a course of action before the EU’s 12 April deadline?

What's been agreed?

After a classic marathon evening of talks at the March European Council meeting, EU leaders have agreed to an extension of the two-year Brexit Article 50 negotiating period. The decision, being dubbed a "flextension", gives the UK two options and piles the pressure on Westminster to agree a way forward over the next few weeks. 

If May's Brexit deal is passed next week, the EU will grant an extension that lasts until 22 May - the day before European Parliament elections. This would give the UK time to pass the relevant legislation.

If the deal doesn’t pass next week, then the UK will have until 12 April to decide a way forward. This coincides with the legal deadline for the UK to give notice on holding EU elections, and European Council President Donald Tusk made it clear that this was a key condition to unlock a longer extension beyond mid-April.

Before going into the implications, there is immediately some good news. There had previously been reports that the EU was considering holding a further summit next week to make the final decision on extending Article 50, which would come after May's third meaningful vote on her deal.

Perhaps fearing the risk of taking the Brexit saga to the eleventh hour, leaders decided against putting off the decision until next week. This takes some of the heat out of what could have been a nerve-wracking week, although Parliament still needs to get its act together and formally change the exit date in UK law before 29 March (although this shouldn’t be too hard).

Cautious Bank of England could still opt to raise rates in 2019

While the Bank of England is clear it'll stay firmly on the sidelines amid the current uncertainty, there are still hints that it could be inclined to hike rates earlier than markets think. As ever, it all depends on Brexit

It all depends on Brexit...

The March Bank of England meeting is probably one of those that policymakers would have ideally liked to skip. The Brexit backdrop makes it very hard for the Bank to say much about the economic outlook, and as might you might expect, the statement contains various references to the ongoing uncertainty. 

Unsurprisingly, the Bank has also kept its cards close to its chest when it comes to the prospect of rate rises, simply saying that further tightening may be required.

Importantly though, we think it’s too early to completely rule out a rate hike this year - although of course, this depends almost solely on Brexit. Here are few possible scenarios:

1 Deal approved and the UK enters a transition period

There are reports that prime minister Theresa May will attempt to bring her deal back to parliament next week for a third meaningful vote. This relies on her finding a satisfactory way to duck Speaker John Bercow’s requirement for a “substantial change”, and even then, the odds still appear stacked against the prime minister's deal.

But if PM May does find a way of getting a deal through, then talk of a near-term rate hike could quickly return. Wage growth is running at a post-crisis high and given that this stems from skill shortages in various parts of the economy, we don’t expect this trend to reverse rapidly. The Bank’s forecast of excess demand at the tail-end of its forecast period implies that more tightening could be needed than currently priced into markets.

You could reasonably argue that with the Federal Reserve and the ECB seemingly on pause for the foreseeable future, it’s hard to see the Bank of England going against the grain. But barring a more severe global downturn in growth, we suspect policymakers will be more inclined to play ‘catch up’. For this reason, we’ve loosely pencilled in a rate hike for November.

2 Article 50 extended

For the Bank of England outlook, a lot depends on how long the Article 50 negotiating period is extended. A short extension until the end of May would keep the risk of ‘no deal’ firmly alive, and this would continue to keep a lid on economic growth. While further extensions might be possible, the risk of the EU saying ‘no’ could increase.

Unless PM May manages to get her deal approved over the course of next week (or before the 12 April deadline to trigger European elections), it seems like the EU might be more minded to offer Britain a long extension to the Article 50 period. In theory, a delay to the end of the year or beyond could open a narrow window for the Bank of England to hike over the summer – on the basis that it could help unlock some consumer spending and give businesses temporary reprieve.

This relies on the economy rebounding fairly quickly though, and it’s equally possible that a long extension leads to a prolonged pause at the Bank. After all, having come this close to the cliff-edge, businesses will be alive to the possibility that it could happen again and investment will stay under pressure.

3 No deal - Brexit

We suspect parliament will do all it can to prevent a 'no deal' Brexit on 29 March, and we still suspect the EU will be reluctant to block an Article 50 extension too if it leads to the UK crashing out of the European Union. 

But if we're wrong, then the Bank of England has suggested rates could go in either direction. On balance though, we suspect 'no deal' would cause a substantial hit to confidence (in addition to significant disruption to supply chains), which makes it much more likely the Bank would decide to cut interest rates in this scenario. 

Switzerland: Negative rates will be new norm for a long time

The Swiss National Bank has kept its easy monetary policy unchanged and revised its inflation forecast downwards. This suggests we shouldn’t expect a rate hike for several years

Monetary policy unchanged

As expected, the SNB has not changed monetary policy, keeping rates unchanged: the interest rate on sight deposits held at the SNB remains set at -0.75%, and the margin of fluctuation of the Libor at three months remains between -1.25% and -0.25%. Despite a slight depreciation of the Swiss franc, the SNB still describes the currency as "highly valued" and continues to intervene on the foreign exchange market, if needed.

Federal Reserve: Dovish Fed signals end to tightening

No policy change from the Fed, but the dot plot diagram shows FOMC members have gone signalling two possible hikes to no hikes in 2019. Should we be worried?

VERY patient

As widely expected the Federal Reserve unanimously left monetary policy unchanged with the fed funds target range maintained at 2.25-2.50%. The Fed noted the ongoing "strong" labour market, but also highlighted that growth has "slowed from its solid rate" in Q4. The statement also repeats the argument that with "muted inflation" the Fed will be "patient" with regard to future moves in interest rates.

The accompanying forecasts and "dot diagram" indicate that the Fed will be very, very patient. Having signalled back in December that it was thinking they could raise rates twice this year they are now projecting no rate changes in 2019 at all. In a further adjustment, they will be tapering their balance sheet roll off to US$15bn per month of treasuries from US$30bn with the process being halted by the end of September.

Unsurprisingly the dollar has reacted negatively to this and treasury yields have fallen too. We had expected officials to take one of their projected hikes out of the diagram for this year, but removing both is a surprise. It seems pretty aggressive given officials have been repeatedly telling us that the US economy is "strong". Indeed, they have only cut their 4Q19 GDP growth forecast from 2.3% to 2.1% and left their core inflation forecast at 2%.

 

Creeping concerns

Such a move will only boost the market conviction that the next Federal Reserve move will be an interest rate cut. Concerns over economic headwinds such as trade protectionism, the government shutdown, weak figures from Europe and China (which Jerome Powell emphasised in the press conference) and the lagged effects of higher interest rates and the strong dollar all do justify caution. The recent weak run of US activity data has also been disappointing while core inflation has undershot expectations. However, today's sharp shift from the Fed may risk exacerbating any business and household concern about the outlook.

 

Should we be worried?

We had been thinking that a September rate hike from the federal reserve remained on the table given our belief that the US growth story was underpinned by a strong jobs market and rising worker pay and the expectation that in the coming months we will get a positive resolution to the US-China trade dispute. Indeed we continue to think the US economy can expand in excess of 2% this year with Jerome Powell also talking of "very strong"  economic fundamentals. We additionally expect core inflation to grind higher to above 2.5%. However, this does not appear to be enough for officials and we will seemingly need to see even stronger figures to get the Fed to react.

 

Calling the top

Given such clear direction from officials and the continued emphasis on "patient", it looks as though we will have to take that September hike out of our forecast. For now, the Federal Reserve is still signalling a bias to tighten policy given the rate hike pencilled into 2020. But with a presidential election later in the year and President Trump keen to gain political capital out of challenging the Fed on any rate hikes, we are sceptical that would happen.

Watch: The ‘stock picker’s market’ in FX

The lack of volatility in the FX markets means it's going to be local stories driving foreign exchange trends. And that, says ING's Chris Turner, is why the pound can be an outperformer amid all the Brexit confusion

Belgian elections: A large Green coalition?

Opinion polls suggest that the centre-right government is unlikely to win a majority at the federal elections. A large coalition comprising the Green parties looks likely

Caretaker government in place

After the fall of the Belgian government in late 2018, a caretaker government was set up, and this is expected to remain in place until the elections in May. The current situation is far from ideal and not conducive to taking necessary financial decisions. Bear in mind that before the government collapsed, it had lost its majority in parliament following the resignation of ministers affiliated with the New Flemish Alliance (NV-A). And a caretaker government has very little power. As a result, there has been no vote on the 2019 budget. A temporary budget based on 2018 expenditures has replaced this for now, keeping the public deficit at close to 1% of GDP.

That said, some plans which had already been discussed before the fall of the government have been voted upon by the parties making up the previous majority.

Prime Minister Charles Michel's aim was to find an alternative majority in parliament for other initiatives. But his efforts have largely failed- a situation we had anticipated, given that it can be difficult for parties to make concessions to opponents ahead of elections for fear of looking weak in the eyes of voters. We continue to believe that this situation will last until the elections on 26 May.

Switzerland: Why too little debt could be a problem

In the European Union, high debt levels are a constant concern. But Switzerland faces the opposite problem and, paradoxically, it could be missing out on extra revenue as a result

Very low debt

Switzerland is an exception when analysing the level of its debt. Gross public debt was equivalent to 41.8% of GDP in 2017, according to the IMF, of which 14.5% of GDP is borne by the federal state (Confederation) and the remainder by the cantons. This is the lowest level of public debt in Switzerland since 1991 and is well below the average debt level of the EU (83.3% of GDP) or the euro area (89.1% of GDP). While other OECD countries have tended to increase their debt as a proportion of their GDP in recent years, Switzerland has seen its debt decrease every year.
 
This decrease in debt follows a succession of budget surpluses in previous years. The budget balance since 2006 has been positive almost every year (except in 2013 and 2014). For 2019, the Confederation's budget could lead to a surplus of 1.3 billion francs (at least). More surprisingly, the Swiss Confederation ends each year with a larger budget surplus than expected at the beginning of the year in the budget. For example, in 2018, the Swiss Confederation recorded a budget surplus of 2.94 billion francs, ten times more than expected, thanks to tax revenues which exceeded expectations, while spending remained under control. Since 2007, only the 2014 financial year closed with a result slightly below the budget forecasts.
To be sure, however, private debt (and especially household debt) is higher than in most OECD countries. 
 

Thailand: Steady economy amid political risks

Prime Minister Prayut Chan-o-cha is likely to remain in power at the general elections next month, though the transition to the new government under him may not be smooth. Absent a significant political shock, the economy will be on a steady 3-4% growth path and the currency will continue to be an Asian outperformer in the medium-term

2018 wasn’t all that bad with firmer growth

Thailand’s economy grew by 4.1% in 2018, the best performance in the last six years. However, it was not much of an improvement from the 4% growth rate recorded in the previous year and underlying drivers of growth weren’t very impressive either. As in 2017, a large contribution to growth came from inventory re-stocking, which isn’t a healthy sign as the potential inventory overhang is likely to keep future output growth subdued. There was some improvement in domestic demand but the all-important investment demand continued to be anaemic and lacked a material boost from public investment. Meanwhile, narrowing external trade surpluses held headline GDP growth down.

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In case you missed it: Central banks take a U-turn

As the Brexit plot thickens with more twists than a House of Cards episode, central banks around the world take a dovish tilt. But as we've seen with the Bank of Japan, ultra-low or even negative interest rates sometimes end up doing more harm than good. Does the ECB need to take note?

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