Financial markets are braced for a plunge in the pound and a sharp fall in UK company share prices if a no-deal Brexit is triggered on Sunday evening.
As the chances of a deal appeared to fade, the pound came under renewed selling pressure on Friday, falling by more than 1% against the dollar as post-Brexit trade talks enter a crunch weekend.
Sterling was heading for its worst week since September, slipping to a low of about $1.3135, before recovering slightly after Germany’s foreign minister suggested that negotiations could possibly continue beyond the Sunday deadline.
The FTSE 100 tumbled by 0.8%, ending the week down at 6,546.
Analysts warned that ending the talks on Sunday without a deal would trigger a fresh sell-off, which could sink the currency close to parity with the dollar, and a rout in UK company share prices when the London stock market reopens on Monday morning.
“If we get a hard Brexit on Sunday evening the market will be shocked,” said Peter Garnry, head of equity strategy at Saxo Bank.
Shares in UK company shares could fall by as much as 7%, he said, led by bank stocks. “Market participants are used to politicians reaching a deal in the last minute, but the UK and EU are far from each other in terms of reaching a trade agreement.”
Faced with the prospect of a no-deal departure crystallising on Sunday evening, the US investment bank Morgan Stanley warned the UK-focused FTSE 250, which tracks the value of the UK’s largest 250 companies outside of the FTSE 100, could fall by as much as 10%.
Share prices in big UK banks would plunge by up to 20%, it said, because the Bank of England might respond to a no-deal departure with negative interest rates to cushion the economic fallout from disruption at UK ports from 31 December.
Q&AWhat would negative interest rates mean for UK consumers?
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In February 2021 the Bank of England told high street banks and building societies they have six months to prepare for negative interest rates. BoE policymakers stressed that the request did not mean a cut in borrowing costs below zero was imminent or even likely, but with few tools left to boost the economy in the event of a downturn, the central bank needs negative rates to be available as an option.
What would happen to my mortgage?
If it’s a fixed-rate mortgage, a cut in interest rates would mean no change. Most households are on this type of deal – in recent years about nine in 10 new mortgages have been taken on a fixed rate.
If it is a variable-rate mortgage – a tracker, or a mortgage on or linked to a lender’s standard variable rate – the rate could fall a little if the base rate is cut. But the drop is likely to be limited by terms and conditions.
Older mortgages often have a minimum rate specified in the small print. Nationwide building society, for example, will never reduce the rate it tracks below 0% on mortgages arranged since 2009 – so if your mortgage is at base rate plus 1 percentage point, it will never fall below 1%. Santander specifies in some mortgages that the lowest rate it will ever charge is 0.0001%.
You will need to dig out your paperwork to see how low your mortgage rate could go.
Will new mortgages be free?
In Denmark, borrowers have been offered mortgages with negative interest rates. Mortgage customers with Jyske Bank were lent money at a rate of -0.5%, which meant the sum they owed fell each month by more than the sum they had repaid. There is no reason why UK lenders could not follow suit.
What happens to my savings?
UK savings rates have already been affected by the two base rate cuts in March 2020 and many easy-access accounts from high street banks pay just 0.01% in interest.
Some banks already charge for current accounts, but it is unlikely that you will soon be forced to pay to keep small sums on deposit – despite the low base rate it is possible to earn 1% or more on a fixed-term savings account.
Wealthy savers are likely to be the first who would face a charge. In 2019, UBS started charging its ultra-rich clients a fee for cash savings of more than €500,000 (£449,000), starting at 0.6% a year and rising to 0.75% on larger deposits. And at Jyske Bank, similar charges apply.
What about my pension savings?
Negative interest rates are bad news for pension funds. If you have a defined contribution scheme you may find the predicted value on retirement falls, and you need to put more in if you have a target finishing date in mind. It is also a bad time to buy an annuity to provide a retirement income, as the returns on these fall when rates are negative.
Under the policy of negative rates, Threadneedle Street would cut its base rate from a record low level of 0.1% to below zero, meaning commercial banks would need to pay interest to place deposits with the central bank. Although designed to encourage lending to the economy, experts warn it would hit banks’ profits and could undermine financial stability.
Morgan Stanley said most economic forecasters had factored in some kind of free trade deal from the start of January, meaning a no-deal Brexit “would represent a genuine and negative ‘surprise’ that markets are likely underprepared for” that could cause severe turbulence.
The Bank of England warned on Friday that failure to agree a deal before the end of the Brexit transition could unleash volatility in financial markets and disruption for customers of UK and EU banks.
Threadneedle Street said that Britain’s biggest banks were adequately prepared to withstand any shocks that could be triggered by the end of the transition at 11pm on 31 December, when UK access to the single market and customs union expires.
It said UK banks could sustain losses of £200bn while continuing to operate safely – far higher than the expected economic fallout of no-deal Brexit and the Covid crisis.
Q&AWhat does a no-deal or WTO-rules Brexit mean?
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If the UK leaves the EU without a deal it would by default, become a “third country”, with no overarching post-Brexit plan in place and no transition period. The UK would no longer be paying into the EU budget, nor would it hand over the £39bn divorce payment.
The UK would drop out of countless arrangements, pacts and treaties, covering everything from tariffs to the movement of people, foodstuffs, other goods and data, to numerous specific deals on things such as aviation, and policing and security. Without an overall withdrawal agreement each element would need to be agreed. In the immediate aftermath, without a deal the UK would trade with the EU on the default terms of the World Trade Organization (WTO), including tariffs on agricultural goods. This has also been referred to by government ministers as an "Australia-style deal". Australia does not have a free trade agreement with the EU.
The UK government has already indicated that it will set low or no tariffs on goods coming into the country. This would lower the price of imports – making it harder for British manufacturers to compete with foreign goods. If the UK sets the tariffs to zero on goods coming in from the EU, under WTO “most favoured nation” rules it must also offer the same zero tariffs to other countries.
WTO rules only cover goods – they do not apply to financial services, a significant part of the UK’s economy. Trading under WTO rules will also require border checks, which could cause delays at ports, and a severe challenge to the peace process in Ireland without alternative arrangements in place to avoid a hard border.
Some no-deal supporters have claimed that the UK can use article XXIV of the General Agreement on Tariffs and Trade (Gatt) to force the EU to accept a period of up to 10 years where there are no tariffs while a free trade agreement is negotiated. However, the UK cannot invoke article XXIV unilaterally – the EU would have to agree to it. In previous cases where the article has been used, the two sides had a deal in place, and it has never been used to replicate something of the scale and complexity of the EU and the UK’s trading relationship.
The director general of the WTO, Roberto Azevêdo, has told Prospect magazine that “in simple factual terms in this scenario, you could expect to see the application of tariffs between the UK and EU where currently there are none”.
Until some agreements are in place, a no-deal scenario will place extra overheads on UK businesses – eg the current government advice is that all drivers, including lorries and commercial vehicles, will require extra documentation to be able to drive in Europe if there is no deal. Those arguing for a “managed” no deal envisage that a range of smaller, sector-by-sector, bilateral agreements could be quickly put into place as mutual self-interest between the UK and EU to avoid introducing or to rapidly remove this kind of bureaucracy.
“However, financial stability is not the same as market stability or the avoidance of any disruption to users of financial services. Some market volatility and disruption to financial services, particularly to EU-based clients, could arise,” the Bank warned.
Publishing its regular financial stability report, the Bank said large UK firms were generally well prepared to continue making cross-border payments. However, it said there was less clarity about the progress of EU companies. “To the extent that gaps remain at the end of the transition period, they are likely to result in some disruption to both EU and UK customers and businesses.”
The pound fell by about 10% after the EU referendum in 2016 and has remained low on the global currency markets since, reflecting the uncertainty for the economy over the UK’s post-Brexit trading relationship with the EU.
Trevor Greetham, the head of multi-asset at Royal London Asset Management, said much of the bad news was already factored into the currency this time around, but that sterling could still tumble by 5% in a no-deal scenario.
“We are hopeful, though not confident, that a political compromise will be found to enable trade UK-EU talks to continue beyond the weekend but it would be rash to base an investment strategy on the basis of one outcome or the other. Both of the arrangements under consideration reduce the growth prospects for the UK economy,” he said.