There may in fact be a hard Brexit later this month, but foreign exchange traders seem fairly certain at this point that there will not be a no-deal Brexit on March 29. That may explain why the pound sterling remains above its floor of $1.32, but it seems optimistic.
A hard Brexit—a likelier outcome than markets are expecting—is the current default position if EU leaders meeting at the end of this week don’t agree. Indeed, it will take all 27 of them to concur on extending the Brexit deadline.
British Prime Minister Theresa May will ask for a delay, per the vote in Parliament last week. But for how long depends on the result of a new parliamentary vote this week ahead of the summit on the deal she has worked out with Brussels. This includes the notorious Irish backstop on border-free trade between the Irish Republic and Northern Ireland and the risk, however slight, it will trap Britain in a customs union with the EU for eternity.
The presumption, after European Council President Donald Tusk expressed his willingness to go along with a longer delay to give the British time for a rethink on their approach to Brexit, is that national leaders will unanimously approve that delay. Given the increasingly fractious undercurrents in the EU, that seems to be quite a presumption. It only takes one member’s veto to push Britain out of the EU this month.
May’s ploy is to scare reluctant Brexiteers, who don’t like the existing deal, into going along with it after all, rather than risk Brexit unraveling with a longer delay. It is a tactic that is working better than expected as reports emerge that not only are members of her Conservative Party reconsidering their positions, but her Northern Irish allies in the Democratic Unionist Party (DUP), and even some Labour Party members as well. It may be enough to get the 75 votes she needs to swing in her direction from the last rejection of the deal.
Still it's a long shot, but not as long as it looked last week, as everyone spent a long weekend looking at the alternatives. The likeliest alternative is a cascade of procrastination that extends the deadline to a year or longer, which according to Brussels requires Britain to participate in EU elections at the end of May, an exercise somewhere between lunacy and absurdity.
This is not even the usual vindictive tactic employed by Brussels, but a serious legal opinion that any European Parliament opening in July without Britain as long as it is still a member, would be in violation of treaties and compromised in its actions.
Ironically, that very European election may be pressuring some EU leaders, for instance French President Emmanuel Macron, into a hardline position to discourage voters from supporting eurosceptic candidates like Marine Le Pen and her National Rally party.
British lawmakers voted against a second referendum last week with a large majority, but nothing prevents a second vote on the subject going the other way in the case of a prolonged delay. This is the cudgel May is using to beat Brexiteers over the head.
It is all in all amazing political theater, and an unprecedented chapter in European relations. Currency traders really have no choice but to take things step by step.
However, the apparent absence of downside pressure on sterling at this juncture suggests not only optimism about avoiding a no-deal exit, but perhaps also a realization that even the worst-case scenario—a default exit in less than two weeks—will not be the end of the world for Britain or its currency.
In the meantime, the only thing with virtually 100 percent certainty is that Bank of England policymakers meeting this week will leave the benchmark interest rate unchanged at 0.75 percent. The plan for tightening monetary policy is on indefinite hold as the Brexit drama plays out, and the desire of some Monetary Policy Committee members to loosen policy for Brexit disruption will have to wait.