Nothing Has Changed: A Hard Brexit Is Coming, By Accident Or Design

So, what has changed for U.K. assets now that Theresa May has succumbed to the inevitable and announced her resignation as Prime Minister?

The pound’s reaction – a pale, knee-jerk bounce after a loss of nearly 4% in the last three weeks against the euro and dollar – gives the answer: not much.

The foreign exchange market’s received wisdom since before the referendum has been that Brexit will do long-term damage to the U.K. economy and it has followed from there that sterling reacts negatively every time a Hard Brexit becomes more likely and rallies strongly any time the U.K. looks like having second thoughts about the whole thing.

Right now, a Hard Brexit is looking more likely. As much as anything in politics is certain, May is certain to be replaced by a more ardent Brexiteer.

A YouGov poll last week showed ex-Foreign Secretary Boris Johnson was the preferred candidate of 39% of Conservative Party members, 26 points ahead of former Brexit Secretary Dominic Raab. But Johnson first has to convince Conservative lawmakers he can lead them, something they refused to do back in 2016 when his decision to back Brexit undercut then-Prime Minister David Cameron.

“The modest support sterling and U.K. rates have enjoyed since her announcement is somewhat remarkable,” said Tim Graf, head of macro strategy EMEA at State Street (NYSE:STT) (State Street. “We suspect that support will prove temporary.”

Graf noted that parliament “has almost no options at its disposal to check any future Prime Minister who wants to leave the European Union without a deal.” (For an exhaustive analysis of why not, read this blog post from earlier this week by Maddy Thimont Jack, a senior researcher at the Institute for Government in London.)

But if the new PM won’t be constrained by procedure, he or she will be constrained by politics and economics. The opposition to No Deal from business, from sitting lawmakers and from the broader electorate is real. The Conservatives will have lost votes to pro-Remain parties as well as Nigel Farage’s Brexit party in this week’s European elections, and the actual disruption from a Hard Brexit is something no Prime Minister will want to own.

Faced with that reality, the new leader will face the same choices: a) deliver Brexit with much economic pain, losing the next election b) abandon it at a cost of piding the Conservative Party, losing the next general election or c) somehow kick the can further down the road, an option which by no means escapes the downside of options a) and b).

There are ways out.

The new Prime Minister could call yet another general election in pursuit of a clear mandate for No Deal, as May did in 2017 (to disastrous effect). Another would be to call another referendum to “confirm” the popular will for No Deal, although that would inevitably pide both nation and party again. But both options could provide political cover, either pushing Brexit through or retreating from it.

Awkwardly, further dithering is not really an option either. Rem Korteweg, a policy analyst with the Clingendael think tank in the Netherlands, argues that the likelihood of continued paralysis in the U.K. puts the country’s fate back in the hands of the EU. The remaining 27 may be more inclined to listen to French President Emmanuel Macron the next time the U.K. asks for more time to play politics with itself and to refuse any further extension of the deadline for Brexit.

At that point, a project that promised prosperity and freedom would finally have ended – as the currency market never fails to remind us – by leaving the U.K. poorer and at the mercy of bigger trading blocs.

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