RaboResearch - Economic Research

The Great Brexit Gamble


  • An election will be held on December 12. Prime minister Johnson is looking for a five year mandate and a parliamentary majority for his Brexit-deal. It is easier for Johnson to win a parliamentary majority in an election than to win a popular majority in a People’s Vote
  • Assuming that clarity on Brexit is the only thing that is broadly desired, party allegiances could potentially break down. The election will be dominated by tactical voting
  • If Johnson’s bet pays off, the new parliament will be able to pass Johnson’s existing deal. “Brexit” will then move to the tricky negotiations regarding the future relationship
  • But if Johnson’s bet backfires, the plot will twist again. A minority government led by Labour could lead the UK to a second referendum, and potentially a Remain outcome
  • The first scenario appears more likely, but opens up the risk of a no-deal Brexit at the end of 2020. A Tory majority may therefore bring plenty of scope for sterling volatility next year

A gamble, but not a blunder

For months, we have held the view that a snap election was inevitable. Ever since prime minister May’s gamble backfired spectacularly in June 2017, it had been very hard –and in our view almost impossible– to get any sort of Brexit-agreement ratified by the British parliament. After hitting this brick wall three times, Theresa May handed over the keys to 10 Downing Street to Boris Johnson. And at some point, as he spread the word that the UK would certainly, unconditionally, really-really-really leave the EU on October 31, prime minister Johnson actually started to believe that he could somehow make it happen. But his parliamentary majority vanished before his eyes and he was forced to seek a three-month extension if Parliament didn’t come to his side of the deal by October 19; clearly, the odds were never in Johnson’s favour.

Some commentators see it as a colossal blunder that Johnson called for an election rather than pushing forward after his Brexit bill passed a second reading in parliament with a majority of 30. We disagree, for two reasons: 1) Boris Johnson has always been more interested in Boris Johnson than in Brexit, and 2) his Brexit-deal reached its peak when it didn’t specify anything about its end-point. The latter allowed for a fragile alliance of Labour Leavers and Tory Brexiteers, which was deemed to fall apart if more time was taken to scrutinize the deal, we think. This is why Johnson dropped his deal before his deal dropped Johnson: the closer the Brexit-deal, the less achievable it would have become because of the unpleasant reality of the details.

While we don’t regard Johnson’s decision as a blunder, the election actually is a huge gamble. The Conservatives have a substantial lead in the polls, as they had in 2017 at this juncture, but the outcome is unpredictable. The party system is in flux and the first-past-the-post electoral system induces tactical voting that can’t be predicted and/or coordinated on a national scale without problems. But in the end, clarity and a direction on Brexit is arguably the only thing that is broadly desired from this election. And even though a People’s Vote would be a ‘cleaner’ way to settle the debate on the UK’s exit from the EU, an election has always been more preferable for Johnson (e.g. he could win a 5-year mandate in the process) and for the other Brexiteers in parliament (e.g. under FPTP, Brexit could pass with <50% of the vote).

A country divided…

The United Kingdom is divided into 650 different parliamentary constituencies (figure 1) and each constituency is represented by one Member of Parliament in the House of Commons. The system that is used to elect the MPs is known as first-past-the-post (FPTP): all a candidate has to do is to simply gain more votes than any of his/her rivals in that constituency. There are therefore 650 separate “Winner Takes All” campaigns and races and the number of seats won by a political party is only indirectly related to the national vote share. This works out well for the two main parties (Conservatives and Labour) and for regional parties such as the Scottish National Party, or the Northern-Irish DUP and Sinn Féin. Meanwhile, the Liberal Democrats and the Brexit Party underperform relative to proportional representation (figure 2).

Figure 1: Constituencies per country
Figure 1: Constituencies per countrySource: ONS
Figure 2: The Tories, Labour and SNP enjoy a “FPTP dividend”; the LibDems clearly do not!
Figure 2: The Tories, Labour and SNP enjoy a “FPTP dividend”; the LibDems clearly do not! Source: Rabobank
Note: Inner ring is proportional; outer ring is FPTP

Traditionally, FPTP also implies that there are lots of safe seats, which hardly change hands and where plenty of votes are ‘wasted’. There are also a number of marginal seats, which an incumbent holds after winning a tight majority in the previous election. The battleground is therefore focused on these marginal seats; a good showing here is instrumental for getting an absolute majority in the Commons.

While FPTP always induces tactical voting, it will hardly ever be as intense as it is for the upcoming election. This is entirely due to the polarized debate on Brexit. The UK’s departure from the EU is breaking down traditional party allegiances, which is why pollsters may find it very difficult to predict the outcome of this election. A survey from YouGov, a pollster, shows that Brexit is a key issue in this campaign. Some 68% of the respondents consider it a top-three issue, followed by healthcare and crime at a relatively large distance (figure 3). Polling suggests that the public opinion is leaning towards staying in the EU, but the UK remains strongly divided (figure 4).

Figure 3: Brexit remains the #1 issue …
Figure 3: Brexit remains the #1 issue …Source: YouGov
Figure 4: … but the country is still divided
Figure 4: … but the country is still dividedSource: Macrobond, YouGov

Tactical voting…

Before discussing how Brexit-induced tactical voting could steer the election, let’s first briefly review the party positions on Brexit:

  1. The Conservatives still want to ‘Get Brexit Doneby October 31. There is an agreement with the EU to settle the divorce and prime minister Johnson has declared that he would then like to negotiate a “super Canada-plus” free trade agreement with the EU by the end of 2020. An extension of the transition period is currently being ruled out.
  2. The Brexit Party wants a clean break. It will not field any candidates against the Conservatives in the 317 seats they won in 2017, in exchange for Johnson’s promises to get Brexit sorted in 2020. Leader Nigel Farage does insist that his candidates will run in Labour-held seats.
  3. There was a time when Labour’s “constructive ambiguity” on Brexit suited a purpose: to blame all mishaps on Tory incompetence. It is now being faced with the problem that it has never been able to shape a coherent Brexit policy either. As it stands, Labour-leader Corbyn wants to re-negotiate a new soft Brexit-deal with the EU, which should then be put to a public vote alongside a Remain option. Meanwhile, Labour has not formally decided yet whether it would campaign against or in favour of its own deal.
  4. The Liberal Democrats have officially endorsed to simply revoke Article 50.
  5. The Scottish National Party wants the UK to remain in the European Union, but Scottish independence remains their primary aim.

Both sides of the Brexit-divide (… and Labour) have an incentive to cooperate, either to get Brexit done or to stop it. In August, we surmised that a nonaggression pact between the Conservatives and the Brexit Party appeared to be more realistic than a similar agreement between Labour and the Liberal Democrats. There are stark ideological differences between a Corbyn-led Labour and a party who actively supported austerity in the Tory-led coalition. Their core beliefs on economic issues are miles apart and not even Brexit can paper over these differences. Nonetheless, there has been some cooperation on the Remain-front. The Liberal Democrats, the Greens and Plaid Cymru have signed up to an agreement not to stand candidates against each other in 60 seats in Wales and England. But in order to make a real difference, nationwide cross-party cooperation between the Liberal Democrats and Labour is needed. For now, this remains elusive.

Meanwhile, the Brexit Party’s unilateral leave alliance with the Conservatives came after months of actually trying to create a bilateral leave alliance. This failed, which led Mr. Farage to announce that he wouldn’t let his candidates stand in the 317 seats that were won by Tory MPs in 2017. While this nonaggression pact appears to be boosting Johnson’s chances of securing an overall majority, it is actually not that straightforward. Mr. Farage’s move does protect a lot of Brexit-leaning Tory marginal seats as it avoids that the Brexit vote is being split, but it effectively works as a ‘floor’. This will make it easier for Johnson to achieve a net gain, but doesn’t necessarily help him to get a majority in the Commons. Note that the Tories actually need to gain seats in the Labour/Leave districts to achieve this, and Brexit Party are not standing down in those constituencies yet. This could spell trouble for Johnson in the so-called “Red Wall”, the c. 50 seats in the Midlands and the North which have been Labour for decades. The presence of the Brexit Party may stop the Tories from getting their hands on the Labour/Leave heartlands.

If voters want to either clinch or stop Brexit, they may need to vote tactically and back a candidate they wouldn't normally support (e.g. if someone actually wants to vote for the Liberal Democrats, but lives in a Tory/Labour marginal seat, he/she may still decide to vote Labour; similarly, voters in Labour/Leave districts which are in favour of Brexit may decide to vote Tory instead of the Brexit Party). Both Leave and Remain interest groups have launched several online tools and apps which tell voters exactly how to vote. These coordination efforts may change the dynamics in the around 100 key target constituencies that have been identified as where tactical voting could swing the election.

… mixed up in a traditional left-right divide

While Brexit has been identified as the top issue among the electorate, it runs right through the more traditional left-right divide. Hence, if Boris Johnson wants to win big, he has to breach the Red Wall in the Midlands and the North. The narrative is that voters in these constituencies experience “the system” to be working against them and are consequently attracted to Corbyn’s radical vision for the UK economy. At the same time, on more cultural issues such as immigration and Brexit, they feel more closely aligned with conservative policies. Political science says that the voters are “cross-pressured”: there are tensions between their ideological viewpoints.

This has been the main reason why Boris Johnson started his campaign in the North, why he is talking about how to best cope with the excesses of globalisation, unfair markets and inequality, why he has cancelled the planned cut in corporate taxes, and why the Conservatives have proposed a massive rise in infrastructure spending to be paid for through public borrowing. It has also created a surprising consensus between the Conservatives and the Labour party: fiscal rectitude has lost its appeal and public spending should rise as much as needed to keep voters happy. If you add this to the relentless uncertainty about the economic outlook, it is not surprising that Moody’s warned of a possible rating downgrade on UK sovereign debt.

Figure 5: Real weekly earnings remain below peak levels…
Figure 5: Real weekly earnings remain below peak levels…Source: Macrobond
Figure 6: …and the squeeze in real pay is widespread
Figure 6: …and the squeeze in real pay is widespreadSource: Macrobond

… leads to a binary election

So far, polls suggest that the Conservatives’ campaign resonates well with voters. The Tories have recovered almost all of the losses that were suffered in the first half of 2019, when the party was rudderless after Theresa May had lost three meaningful votes. But since the election of Boris Johnson as leader, the Conservatives actually have been able to take the wind out of Farage’s sails. The rise in the polls has come almost completely at the expense of the Brexit Party (see figure 7). Risking yet another loss of face in a general election, the leader of the Brexit Party decided to walk back on his previous threat to stand a candidate in every seat unless Boris Johnson shifted to ‘clean’ Brexit position (i.e. a WTO Brexit). This has led to the initiation of the unilateral nonaggression pact, as discussed previously.

Figure 7: The Conservatives have extended their lead in recent weeks
Figure 7: The Conservatives have extended their lead in recent weeksSource: Various pollsters, Rabobank calculations

That said, the jury’s still out whether this will actually benefit the Tories as long as Brexit Party candidates are still standing in the Labour Leave seats. But even a small positive effect in terms of enabling the Conservatives to retain seats they might otherwise have lost to the Liberal Democrats could be of significant consequence, especially if the other side of the Brexit divide continues to fail in coordinating its efforts.

The polls also indicate that Labour and the Liberal Democrats would have a lot to gain if they find a way to consolidate the remain vote. But in spite of all their rhetoric on the long-lasting economic and social damage of Brexit, both parties are still displaying tribal behaviour and refuse to undertake a pact to actually try and stop it from happening. And as long as the Liberal Democrats don’t want to recognize that the only realistic way to stop Brexit is to temporarily support a Labour minority government in order to secure a second referendum, it is unlikely that such a pact will happen.

This will make it a rather binary election, with just two realistic scenarios. There will be either a Tory majority government that will be able to pass the existing Withdrawal Agreement Bill and commences the second phase of the negotiations, or there will be another hung parliament.

Figure 8: A Tory majority is the most likely scenario at this stage
Figure 8: A Tory majority is the most likely scenario at this stageSource: Betfair Exchange, Rabobank calculations
Figure 9: Business investment has stagnated, but a recovery remains unlikely
Figure 9: Business investment has stagnated, but a recovery remains unlikelySource: Macrobond

Scenario 1: A Tory majority

If the Tories get a majority it should be relatively straightforward to pass the existing Withdrawal Agreement Bill. The probability of yet another rebellion should also be fairly low. Many of the Tory MPs who rebelled against the deal were either forced out of the party or decided to step aside voluntarily. They are generally replaced by candidates who can subscribe to Johnson’s Brexit. There’s also still plenty of room for interpretation with regards to the future relationship (e.g. the commitment to “uphold the common high standards” regarding regulation is a weak one). This ambiguity should be enough to satisfy the ‘true’ Brexiteers from the European Research Group.

However, Johnson has not been significantly challenged yet on how exactly he expects to negotiate a trade deal without an extension of the transition period. But the deadline for such an extension, possibly until end-2022, is already on June 30. This creates the prospect for a no-deal cliff edge at the end of 2020. The election will therefore not bring the certainty as claimed.

It is expected to take much, much longer than the remaining eleven months to negotiate a comprehensive free trade agreement. There has to be a formalized mutual recognition of each other’s regulations, for instance, but the decision to shift the level playing field commitments to the non-binding political declaration suggests that the UK may decide to diverge. And if the UK indeed uses Brexit to undercut EU regulations –in order to strike deals with the United States, for instance– the best trade deal that it can probably get with the European Union is a very basic one; note that various EU leaders have frequently raised the danger of the UK developing into another competitor on the continent's doorstep. There is therefore an inverse relationship between UK divergence and the depth and breadth of any future trade agreement with the EU.

The belief that a Conservative victory on December 12 provides businesses and households with certainty is misguided. The costs and benefits of a ‘Canada-style’ trade deal have never been properly debated, but the idea that it could be a worthy substitute for the current relationship is absolute nonsense. A trade deal that is appropriate for a country which does only c. EUR 100bn in combined trade with the EU each year, is roughly 6000 km away, and which is not strongly integrated in regional supply chains, can’t be appropriate for the UK without accepting that there will be significant economic losses. In other words: the UK risks raising high barriers to trade with a large economic bloc at its doorstep in order to get as much freedom as possible to trade with countries further away. It’s trying to defy gravity, and that typically doesn’t work out well.

More time to secure a deal that is actually thought-through is needed. If Johnson says he can do a deal before the end of 2020, it will surely mean that the UK is just signing up to the EU’s demands, ‘happy’ that they can tell the broader audience that Brexit is done. If Johnson refuses to extend and to sign up to the EU’s rules, the UK risks leaving the EU without a trade agreement in 2020, which would imply a significantly harder Brexit than is currently envisaged.

Scenario 2: A hung parliament

If the Tories don’t get a majority, it is probable that there will be another hung parliament. The polls currently indicate that this is an unlikely scenario, but this was also the case in 2017 at this juncture. And if the elections again morph into a two-horse race between the Conservatives and Labour, we could still end up a with a broadly similar outcome as in 2017.

A hung parliament would give Labour a chance to form a minority government, with outside support from the Liberal Democrats and the SNP. An inconclusive election which was dominated by Brexit could then be used as a pretext for a renegotiation and a second referendum to settle Brexit ‘once and for all’. This creates new uncertainties, but might in the end lead to a closer relationship between the EU and the UK and an economically less damaging Brexit. Labour might also try to seek support for some of its radical economic policies, e.g. the nationalization of utility industries, but we don’t expect that such policies will find much traction in a hung parliament.

Still more volatility ahead?

Currencies tend to react favourably to expectations of a strong, liberal and market-friendly government. The polls indeed indicate that the UK is likely to be handed such a government, even though the Conservatives do their utmost best to mar their business-friendly credentials.

A strong parliamentary majority for the Tories looks to be vital, as prime minister Johnson would then be less exposed to the Tory Brexiteers, which have seen their influence rise relative to the moderate Tory MPs. This could give Johnson some more room for manoeuvre, allowing him to change tack and ask –if push comes to shove– for an extension of the transition period. Parliamentary consent is not required for such an extension, as it is a decision to be made by a joint committee of the EU and the UK, but there could also be plenty of Brexiteers in influential Cabinet positions. The decision to extend or not is likely to turn into a bargaining chip and provides the next stage for yet another Brexit showdown.

A tight majority of just a few seats weakens his hand and Johnson then risks being pulled in multiple directions, which potentially leads to in- and external political conflicts and a cliff-edge Brexit at the end of 2020.

Figure 10: Negative bets had reached extreme levels
Figure 10: Negative bets had reached extreme levelsSource: Bloomberg, Macrobond

The recovery in sterling, from GBP/USD 1.20 in early-September to close to 1.30 now is reflective of an improvement in sentiment. We would however also argue that the recovery of sterling was amplified by the fact that speculative short positions had recently reached near-record levels (figure 10). These positions have dropped back markedly in recent weeks and are currently at their lowest level since May. While the market is still short sterling on a net basis, it is evidence that the recent round of position adjustment is now over.

We have attempted to squeeze the current complexities of UK politics into a binary universe and it looks likely that a slight relief rally would likely follow a strong victory for Johnson in December. What this logic does not take into consideration, however, is that the trade negotiations still have to be tackled. If these are unsuccessful the UK may still face a disorderly Brexit at the end of the transition period in just over a year’s time.

Since the Tory party has shed itself of many of its moderate MPs, there may be a greater risk that differences between a Johnson government and the EU will appear during the trade talks. If these talks do not go well, the risks of a no deal Brexit would again rise since a Tory majority with several Brexiteers in the cabinet could be disposed to this outcome. So after an initial period of relief, a Tory majority may therefore bring plenty of scope for sterling volatility next year.

Stefan Koopman
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 71 21328

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