Forex Institutional Research: UBS Brexit Report

Forex Institutional Research: UBS Brexit

UBS: Brexit Renegotiation, referenda and rate calls

Key quotes from the report: 

Chances of a ‘successful’ renegotiation have risen European Council President Donald Tusk’s proposed ‘new settlement’ between the UK and the European Union (EU) implies that the chances of a deal have risen at the February (18/19) European Council meeting. In our earlier extensive research piece, ‘Brexit: EU can go your own way?’ we saw the mostly likely time for a referendum as being this Autumn. But while there is still some risk of last minute problems, recent developments mean the chances of a June referendum have increased.

While a September / October vote still cannot be ruled out, we think the market should ‘plan’ on the basis of a vote in June. But public opinion has narrowed Public opinion between staying in and leaving the EU has narrowed sharply. There remains a significant proportion of people saying they ‘don’t know” how they will vote. The immigration crisis has clearly been one factor behind the narrowing of the polls. We revise our ‘remain’ and ‘leave’ probabilities in accordance with the polls and suggest that the probability of the UK leaving the EU is ‘up to 40%’.

A June vote partly behind last week’s removal of our May hike call The earlier date of the referendum and the increased uncertainty over the outcome is one reason why we now think the Bank of England will not be able to raise its policy rate in May. With some softening in underlying growth, we remove the May rate hike call, leaving the first hike in November.

Sterling has fallen hard, but could well have further to go Since the middle of November, the pound has been under sustained pressure, falling more sharply than at any time since the financial crisis.This has happened despite a relatively steady economic backdrop and, in our view, has been driven by worries attached to the forthcoming referendum. With the polls likely to continue to point to a very close contest and an uncertain outcome, this event-induced weakness could have further to go over the coming months.

Front-end rates have dropped sharply, but aren’t likely to rise soon There has been a dramatic shift in rate expectations at the shorter end of the yield curve, with a cut actually now deemed more likely than a hike this year, and a full hike not priced in for more than two years. This is starkly at odds with the Bank of England’s view, with the February Inflation Report forecast for CPI at the 3y horizon well above the 2.0% target. A significant reversal of the rally is unlikely for now, though if the vote is ultimately for the UK to remain in the EU, we expect a swift correction thereafter as the MPC is likely to sound more determined than it does now to get moving on the tightening path.

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