"It's A Shit Show": Likelihood Of UK Crashing Out Of EU Next Week Is Higher Than It Has Ever Been

UK Prime Minister Theresa May must enjoy ritual humiliation, because despite warnings from European Council President Donald Tusk that the EU likely wouldn't accept May's request for a brief Brexit extension, the Prime Minister traveled all the way to Brussels on Thursday so she could hear the EU27's rejection in person. The bloc is insisting that it won't authorize an Article 50 extension unless a meaningful vote on May's deal succeeds (it has already been rejected twice, both times by historic margins), yet May has continued to grovel, because, at this point, it's all she can do (other than resign, that is).

May

With the EU increasingly indifferent to a 'no deal' Brexit, and the UK's emergency planning entering its most advanced stages, the House of Commons has gone full-on 'Lord of the Flies', with backbenchers once again scheming to wrest control from May, and frustrated cabinet ministers have been telling any reporter who will listen that May's days are numbered, and to expect her resignation at any minute.

Meanwhile. journalists and analysts have been baffled by May's continued insistence that MPs must choose between her deal, no deal or no Brexit. Even the most discerning observers in the Brexit press corp have no idea what might happen next, and although it doesn't take a genius to realize the wheels have finally come off May's Brexit clown car, Wall Street banks are finally beginning to revise their projections.

And while they're still probably still underestimating the probability that the UK crashes out of the trade bloc without a deal at the end of the month (just like they underestimating the likelihood that UK voters would opt to leave the EU), a team of analysts at Deutsche Bank that has been closely tracking different Brexit potentialities has raised the odds of a no-deal exit to their highest level yet - to 20%, from 15% in a prior assessment.

Online betting markets are also pricing in rising odds of 'no deal', though traders continue to see an orderly exit as still the more likely outcome.

GBP

However, a no-deal exit isn't the bank's base case: It continues to expect the EU to approve a long-term Article 50 extension after May resigns and triggers another general election, ushering in a wave of unprecedented political instability.

Ignoring the fact that nobody in Brussels wants the UK to participate in the upcoming European Parliamentary elections, the analysts believe it's more likely that the EU will cave at the last minute after May's deal is rejected for a third time. Seeking to avoid blame for a no-deal exit (peculiar logic since much of the blame for the political dysfunction in Parliament has been assigned to the Tories), the EU will allow a long-term extension as May's government collapses and a springtime general election is called.

What happens if May's deal fails again? Neither Prime Minister May, nor Tusk were clear on this outcome. It is possible the EU27 do not offer a further extension of Article 50, but more likely is that the EU27 will continue to seek to avoid blame for a no deal, and at an emergency Council next week would offer a longer extension to the UK (perhaps to the end of 2019).

It will then be the UK government's decision as to whether to go ahead with a long extension. May indicated in parliament today that she would resign should the UK extend Article 50 beyond the EU Parliament elections. At the same time, however, ministers have said that it would be up to the UK Parliament to decide on the next steps in a series of votes.

Curiously, the bank still assigns a higher probability of May winning the vote on her withdrawal agreement than the UK leaving later this month without a deal.

But virtually no matter what happens, the team expects the pound will only continue to weaken.

As mentioned, we remain of the view that the risk of a no deal Brexit at the end of this month remains low. In a worst case scenario, we anticipate the government will seek an emergency extension of Article 50 even as late as the end of next week, should the third attempt to ratify the Withdrawal Agreement fail.

Nevertheless, it is not an exaggeration to say that government strategy appears to be being made off the hoof, and with greater concern for political considerations than for pragmatic outcomes. As such, the risks of a last minute accident have increased and we ascribe a 20% probability to a no deal outcome at the end of next week, the highest we have ascribed thus far.

Second, our bullish base case scenario, that of Prime Minister May's deal being ratified at the third time of asking, appears relatively less likely now in the light of May's political authority having been damaged to such an extent, as well as little sign entrenched ERG opposition is waning. While we do not discount the possibility of May winning the vote, we ascribe a lower relative probability (25%) to it than before.

Third, should the third meaningful vote fail and the UK secure an emergency extension from the EU27 next week to beyond the EU Parliament elections (55% probability), we do not view this as a bullish outcome. In a best case scenario, Prime Minister May would remain in charge long enough to hold indicative votes in parliament in April. Parliament might then be able to agree on a softer form of Brexit via the political declaration on the future relationship, or a second referendum.

But as we have seen in the last few months, the prospect of the present government being able to implement such policies may be limited, and there is a high probability of the government disintegrating and an early general election resulting. Moreover, should May leave before such indicative votes were held, a resulting Conservative Party leadership contest could prove to be extremely toxic, with the winning candidate likely to have fought on a no deal Brexit platform. In this scenario as well, an early election seems the a high probability, after the Conservative Party splits. In summary, we are not confident about a long extension being a bullish outcome for GBP.

And as if the reputational hit to the UK hasn't been clear enough after months of "Project Fear" and reports about the Conservative Party coming apart at the seams, EU officials have embarked on an "I told you so" campaign, offering some choice assessments with the Guardian for a story about how the Brexit process has destroyed the UK's reputation as a "model of pragmatism and diplomacy".

"A shit-show that just goes on and on," said one official. "Makes you wonder how they ever ran an empire," said another. "British politics is quite broken at the minute," said Lisa Chambers, the Brexit spokesperson for Fianna Fáil, the main opposition party, more diplomatically. "People have been surprised just how chaotic it’s been"

At this point, "a shit show" is putting it mildly.

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