The Long and Arduous Road to Brexit

Brexit could take a lot longer than everyone thinks. Jacob Nell, Morgan Stanley’s Chief UK Economist, plots a timeline of the political hurdles that must be cleared before Brexit is official. It will be 2019 at the earliest before all of the bureaucracy and political wrangling is complete. “But we think it will take considerably longer — likely several more years — to complete new trade arrangements,” he says.

And the longer it takes, the more likely UK consumer confidence and investment suffers. That’s why Andrew Sheets, Chief Cross-Asset Strategist, expects further declines in UK, European and global economic growth, the value of the British pound, and also UK and European stocks. 

“Our foreign exchange strategists believe the British pound could ultimately fall to $1.25-$1.30 and our equity strategists believe that European and UK stocks may need to correct a further 7-10%,” says Sheets. While that might sound harsh, in light of the immediate impact on the market after the vote, he thinks it’s consistent with the uncertainty the vote has created.

“This is at least a two-year process, and as such it’s likely to delay investment and hit consumption if consumers feel less confident about the economic situation or the value of their homes,” says Sheets.

The size of economic impact depends on the political resolutions ahead, but Morgan Stanley economists broadly expect uncertainty over the next 18 months to knock 1.5% off UK GDP, about 0.8% off euro area GDP and about 0.5% off global GDP. 

UK Prime Minister David Cameron resigned on news of the 51.9% referendum vote to sever the country’s 43-year relationship with the EU. The UK Conservative party will elect a new leader — who will become the new UK PM — by September 9, and a new government could be in place before the Conservative party conference during the first week of October, says Nell.

Exit negotiations are expected to begin a few months after the new UK government is in place. Under the EU rules, there’s a maximum of two years to complete the exit, putting the earliest leave date at 2019. 

Nell thinks of it as a three-step process, beginning with the UK government agreeing on an exit policy. That could take several months from the formation of the new government in September. Then there’s the actual negotiations with the EU around the terms of the exit, which could be delayed because of French and German elections in 2017. And finally the most critical point: what trade policy the UK government will decide upon.

“The UK has a number of choices,” says Nell. “It’s still unclear whether the new government will adopt a Norwegian approach, which prioritizes access to the single market but is also willing to accept free movement of labor; or whether it will prioritize control over immigration and have reduced access to the single market.” Clearly the latter would have greater economic ramifications.

Nell thinks not. “We think out means out. The Conservatives have a Parliamentary majority, time to complete the exit before the next scheduled elections in 2020 and a manifesto commitment to honor the referendum result.”

There is definitely a higher risk of Scottish secession than before the Leave vote, given Scotland’s overwhelming vote to Remain, but that too would be a long time coming, says Nell. “A second Scottish independence referendum requires firstly a political deal with the UK government to pass another referendum bill and, secondly, a political deal with the EU to give Scotland assurances on continued EU membership before holding a referendum.”

For more Morgan Stanley Research on how Brexit could unfold, ask your Morgan Stanley representative or Financial Advisor for the full report, "From Here to Brexit?" (Jun 28, 2016). Plus, more Ideas.