There have always been a series of scenarios since the Brexit referendum three years ago. The new prime minister (PM) has dramatically changed the various probabilities.
These are our current guesses:
By 31 October: no deal Brexit 45%; general election 50-55%; leaving with a deal 0-5%. (There is also a chance of a short extension were there to be a general election).
After 31 October, probabilities are even more of a guess: early general election 80%, in which case Conservative majority 20%, Labour majority 10%, Conservative minority government 30%, Labour minority 40%. There is perhaps a 20% chance that the current minority government stumbles on for another year or more.
A Labour minority government (with Lib Democrats and Scottish Nationalists) would go for a referendum, the outcome of which is arguably 50:50 (polls show a lead for Remain by the same amount as they did before the referendum in 2016).
If we combine the probabilities before and after 31 October, the prospects of a no deal exit are well above 50%. Remain is a possibility (given a second referendum which voted to Remain) and leaving with a deal still has a slim chance.
Implications for sterling: a ‘no deal’ is being priced in but there would still be 10-15% downside given immediate disruption. Longer term, were the Conservatives to win a general election and Brexit proved to be less damaging than feared, there could be a decent recovery. A Labour government would potentially be bearish for sterling. But a minority Labour government and a referendum vote to Remain might reverse at least part of the decline over the last three years. Leaving with a deal, although unlikely, would be the most bullish scenario for sterling.
Implications for UK equities: with most of their earnings from overseas, a weaker sterling would support the sterling price of most FTSE 100 companies. Domestically-focused companies would suffer.
Implications for UK government bonds: the Bank of England would probably ease policy on a no deal Brexit, which would lead to a rally in sterling bonds. The sovereign credit rating might be cut from AA to AA- but market implications of that would probably be modest.
Broader implications: ‘no deal’ Brexit would be a ‘risk-off’ event, bearish for the EU, hitting the euro and European equities. But the effects would probably be modest, certainly much smaller than those on the UK.