Scotland Is About To Have Its Own Currency And Much More: How JPM Sees Brexit Playing Out

Several days ago, we showed a schematic of what Citigroup thought the post-Brexit political timeline would look like. This was released before Brexit was official.



Now that Brexit is official, JPM's Malcolm Barr has come out with his base case forecast of "How Brexit Happens." For those following the constant drama, there is little new here, except for one thing - the thing that caused a mini scandal earlier today during the EU Summit between Juncker and Rajoy - namely the treatment of Scotland. Here JPM said that it now expects Scotland to vote for independence and introduce its own currency before Britain leaves the European Union in 2019.

"Our base case is that Scotland will vote for independence and institute a new currency at that point (2019)," JP Morgan economist Malcolm Barr said in a note to clients on Wednesday. Scottish First Minister Nicola Sturgeon will meet European Commission President Jean-Claude Juncker on Wednesday afternoon, seeking a way for Scotland to remain in the EU. As Reuters reminds us, Scotland voted to stay in the EU in last week's referendum, putting it at odds with the United Kingdom as a whole, which voted 52-48 percent in favor of Brexit.

If JPM is right, it means a historic split is in store for the United Kingdom which will see Scotland split politically from England and allign itself with the EU, something which would likely inspire a fresh wave of secessionist movements across Europe. Or, as the market would say, "bullish."

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Full note from JPM's Malcolm Barr

How Brexit happens - our base case

There are myriad uncertainties in how the UK’s relationship with the EU will evolve in the wake of the referendum. In our minds, however, it is useful to lay out a base case as to how we think things will play out from here. It is highly unlikely events will align exactly to this script. But it useful to go through the exercise to help identify some of the key uncertainties along the way.
Phase 1 – Election of a new Conservative Leader and PM (result declared  9th September)

The near 125,000 members of the Conservative Party will choose from 2 candidates selected by MPs. Polling suggests approximately 75% of that group were pro-Brexit at the early stages of the campaign. It is very likely that the new Conservative leader will be elected on a platform of implementing the referendum result and taking the UK out of the EU.

Phase 2 – Article 50 (2016)

The incoming PM is likely to seek Parliamentary assent for submitting the formal article 50 request to leave the EU. With the EU refusing to begin talks before the article 50 request is submitted, our base case is this happens by the end of the year.  Constitutional experts argue about whether this is strictly needed or whether the new PM could act unilaterally. In practise we think it inevitable that the new PM would seek a Parliamentary assent given that the referendum is not legally binding. In our view, this is the crucial point wherein Brexit could be stopped, if it is to be blocked. Enough Conservative MPs (at this stage, we guess close to 20) would need to defy the leadership to prevent a motion from passing. This would likely generate a confidence vote and possibly a new general election if it occurs. Our base case is that Conservative MPs will fall in behind the leader and implement “the will of the people” as expressed in the referendum.

Phase 3 – Post Article 50 (2017)

Negotiations on the form of the EU exit begin soon after the article 50 request is submitted. On the EU side, the Commission will be acting on the basis of a mandate from the Council, and it appears representative from the Council will be involved on an ongoing basis. On the UK side, parties representing the constituent nations will likely be present. The EU will likely attempt to focus on the issues relating to exit in the first instance, rather than those relating to the future relationship with the UK. The UK side will likely seek to push toward the latter set of issues, and to seek as much access as possible to the single market while restricting free movement of labor.  In our base case, negotiations on exit issues will make progress, but progress on the forward looking issues will be negligible as time passes.

Phase 4 – Decision time (2018-19)

The UK will likely spend the first year of the negotiating process seeking to establish access to the single market on terms very similar to those seen during EU membership without accepting free movement of labour or contributions to the EU budget. We doubt this will be successful. Hence the UK will ultimately be forced to choose between a “Norway” option (accepting free movement of labour, EU regulations and budget contributions in return for full access to the single market) or an arrangement which has significantly less market access. At this point in time, the latter appears more likely. This means that access to the service sector (in particular) in the EU will likely be curtailed, along with some constraints on trade in goods. To the extent that UK economic growth is very weak during the negotiating process, the relative importance of market access versus migration control will shift in favour of the latter. However, our base case is that the hit from EU exit will demonstrate itself as a persistent drag on a positive growth rate, rather than generating  an ongoing contraction. As a result, the extent to which economic under performance will motivate a reassessment of UK priorities is ambiguous.
The UK will want to see the exit from the EU completed ahead of the general election in 2020. Submitting the article 50 request in late 2016 means that the standard two year negotiating period will expire in late 2018. However, the UK will likely secure agreement to extend the discussions into 2019, as the focus shifts onto the detail of a set of sectoral arrangements which provide some access to goods sectors beyond WTO terms. Discussion on access to some sectors extending beyond the WTO baseline will likely run beyond the 2020 election, while some sectors will see a reversion to WTO rules for a period while subsequent discussions are promised.
During all four phases of the above, we expect there to be clear evidence of multinational operations shifting the location of their activity out of the UK given the regulatory uncertainties. Financial services are among the sectors that will be most exposed to this process. Even if the UK begins to signal that it will compromise on other priorities in order to secure “full” access to the single market in financial services, there is a clear risk that euro-denominated activities relocate to within the EU simply to ensure continuity of relationships. In the event that it becomes clear that a given EU capital is the destination of choice, there is a possibility that this change could occur relatively quickly. The micro-economics of wholesale financial markets points toward sizeable externalities associated with the sharing of information and linkages between markets, hence its tendency to “clump” together within each time zone. 


Intersecting the UK's EU exit process is likely to be pressure to hold a new referendum on Scottish independence, which we expect will ultimately generate a vote shortly before the UK leaves the EU in 2019. Our base case is that Scotland will vote for independence and institute a new currency at that point. We will cover this issue in detail in a subsequent email.

Non-EU trade negotiations

As the UK’s likely exit from the EU becomes more concrete, there are three issues regarding non-EU trade. First is the need to renegotiate the UK’s trade arrangements with over 50 countries which were established while the UK was part of the EU (with the UK having signed them as part of the EU, they no longer apply once we exit). Second, the UK’s membership of the WTO has also been on the basis of its membership of the EU. The head of the WTO has stated that it is likely the UK will have to renegotiate the terms of its WTO membership, as at least some members will not be happy to simply allow UK membership to continue. Third, leave campaigners argued that the UK would be able to strike its own trade deals with countries like the US, China and India upon leaving the EU, so there may be the beginnings of some effort in that direction.
All of the above issues are likely to prove intricate and time consuming. The UK starts from a position where it does not have a deep well of resources and experience within the civil service to deal with trade issues. The UK’s negotiating position in these discussions is also likely to be very weak. The simultaneous loss or scaling back of such a large number of trading relationships upon EU exit is likely to be a blow to UK exporters, meaning the need to get a successor deal is more urgent for the UK than for our trading partners. The UK may hope that progress on these issues could be made both before the EU exit is completed and before the full set of follow-on arrangements in our relationship with the EU is clear. However, our non-EU trading partners are likely to want to see the detail of the UK’s relationship with the EU before considering the detail of any bilateral deal with the UK, as there are important interdependencies between those sets of relationships.  Put all of this together, and it is likely that the UK’s access to non-EU markets will become markedly more constrained in the wake of the EU exit for a period of years. And to the extent that the UK is able to secure “quick” deals, it is unlikely they will be on terms which are advantageous to the UK.