Janus Henderson: Brexit – the end of the beginning

Multiple sources suggest that UK and EU negotiators have reached a draft agreement on Britain’s terms for leaving the EU (the withdrawal agreement), including backstop mechanisms designed to ensure that Brexit does not create a hard border in Northern Ireland. The next challenge facing the prime minister is to sell the draft exit treaty to her cabinet, which is formally meeting at 2pm today to discuss the reportedly 500+ page draft document. The broad plan here seems to be to get cabinet approval today, then get a formal agreement signed off at a special EU summit in late November, before seeking UK parliamentary ratification in December.

Getting cabinet approval today will be the first of many challenges for Theresa May’s Brexit process. It is widely reported in the UK press that a handful or more of the 22 cabinet ministers oppose the plan and are close to resigning. While two or three ministerial resignations would probably not stop the Cabinet giving its collective support for the deal today, they would raise big questions about the Prime Minister’s ability to get parliamentary approval later on.

For some time, it has been clear that UK parliamentary ratification loomed as the biggest threat to the UK-EU withdrawal agreement. As things stand, the House of Commons arithmetic looks very challenging for Theresa May, with a significant number of Conservative MPs and the Democratic Unionist Party (DUP) threatening to vote against the deal. While there is a decent chance that the Prime Minister will ultimately be able to overcome the opposition she faces here, that process is likely to involve many weeks of disconcerting public hostilities. It is quite possible that the treaty is rejected the first time it is presented to Parliament and threats of a leadership contest, a general election or a second referendum will be needed to get it over the line in a second hearing in the New Year.

Financial markets celebrated yesterday’s agreement by sending sterling higher against all the major currencies. We had some FX hedges in place in our UK strategies, in anticipation of such a withdrawal agreement bounce but do not see this as being the start of a sustainable uptrend in the pound. Even if the cabinet does approve the deal today, the difficult process of parliamentary ratification is likely to keep a lid on sterling optimism in the weeks ahead.

Yesterday’s political progress should be seen as no more than the first few steps down a long and difficult road. It has taken more than two years to get this far and there is a long way to go. Expect more surprises, setbacks and market volatility.