May’s confidence vote – just one step in a quagmire

16 Dec 2018

Philip Shaw, Victoria Clarke and George Brown

Investec economists

PM wins support of her own MPs, but questions remain over future of her Brexit deal as sterling continues on its roller coaster journey

Theresa May clung on to power on Wednesday night after a leadership contest that saw her win a no-confidence vote in her own party by 200 votes to 117. But the divisions within her party were laid bare, and uncertainty remained in the foreign exchange markets, with sterling continuing on its Brexit roller coaster journey.
Such a challenge had of course been touted for some time. However the catalyst for gathering the 48 plus letters necessary was the Prime Minister’s postponement of the “meaningful vote” on Brexit which had been set for 11 December. The irony, however, is that it was likely that Mrs May would have lost the vote by a significant margin, which in itself could have triggered enough momentum behind a leadership challenge.
According to some in the Conservative Party, in an attempt to shore up support she had allegedly told backbench MPs that she would not lead the Conservative Party into the 2022 General Election, although some have contested this version of events. 
Mrs May still faces an uphill battle to get changes to her Brexit deal through the EU, her Cabinet and Parliament.
Despite her victory, Mrs May continues to face almighty challenges. She still faces an uphill battle to get changes to her Brexit deal with the EU which are acceptable to Parliament and, indeed, which get approval from her own Cabinet. If not, her position could become untenable as party leader and she could be persuaded to stand down. 
However, Conservative party rules dictate that a leadership challenge is carried forward if 15% of Conservative Members of Parliament (48 MPs at present) write letters to the Chairman of the 1922 Committee of backbench MPs, calling for a confidence vote. By surviving the vote, another challenge cannot be brought against her as leader of the party for another 12 months.
But regardless of the result, this vote is separate from a no confidence motion against the government; it relates solely to the leadership of the Party and the process rests with the 1922 Committee of backbench MPs. Mrs May could still face the threat of another party calling a vote of no-confidence against her government.
Many will breathe a sigh of relief after the result, as  full-scale leadership contest would delay the Brexit process to a significant degree, with the government working towards holding its ‘meaningful vote’ in Parliament, or alternative course of action, not later than 21 January 2019.

Strong and stable?

Mrs May has emerged intact, albeit somewhat battered, from the vote. But despite her margin of victory, 83 votes, she is still likely to face considerable ongoing pushback against her Brexit deal and her management of Brexit going forward. As noted, there is nothing in the rules to say that she has to, or should, step down if she only scrapes through. If she continues, then it is as we were in terms of the Brexit process.
Mrs May will now go to Brussels and try to wring concessions on the deal from the EU27, especially on the Irish backstop. While it seems very unlikely that there can be any changes to the Withdrawal Agreement itself, the EU27 will probably be open to changing the wording of the political declaration on the future relationship.
Theresa May, U.K. prime minister, left, shakes hands with Jean-Claude Juncker, president of the European Commission, ahead of talks in Brussels, Belgium

Theresa May will return to Brussels to seek further reassurances from Jean-Claude Juncker, president of the European Commission

Moreover it has been suggested that a “legal codicil” could be added to “clarify” the nature of the backstop, perhaps by insisting that the EU27 strikes a trade deal with the UK, to prevent the backstop being triggered or to limit the UK’s time spent in it.
In short, while our baseline view is still that a deal will be reached and passed in UK Parliament early in 2019, much hinges on the extent of Brexit changes to which the EU agrees, especially on the Northern Ireland backstop. 
Despite her, victory, it is not guaranteed that Mrs May will remain PM for that long. While she cannot face a formal challenge for 12 months, it would be very difficult for her to continue if she did not carry the backing of her Cabinet. As a result, we would not rule out a new leader at some stage or an extension of Article 50. 

Return to Brussels

The scale of the problems that Mrs May faced were laid bare after she met with European leaders on Thursday evening, at the last EU Council meeting of 2018. 
Reports varied on how warm a reception she received in Brussels, but the summit was inconclusive in terms of any new compromise, although that was as more or less as expected. Donald Tusk’s statement following the summit reiterated that the Withdrawal Treaty was not open to renegotiation, a position that has been pushed by European leaders including Angela Merkel ever since PM May decided to postpone the meaningful vote.
Given that the Withdrawal Treaty, a legal text, has been agreed we believe that there is little chance for any reworking at this stage. We suspect that the EU will offer some reassurances over the all contentious backstop. Indeed Mr Tusk tried to push the point that it was intended to be temporary in nature within his official remarks.
the same underlying issues remain, in the fact that PM May has an incredibly difficult task in pushing her deal through Parliament.
However we suspect that any side letters, legal codicils or any of the other reported ideas will fall short of a legally binding text, which Tory MPs would want to see. In short the same underlying issues remain, in the fact that PM May has an incredibly difficult task in pushing her deal through Parliament.
In terms of the way forward, there is still no word on when the meaningful vote will take place, although Downing Street have confirmed that it will be in January. Ahead of that another EU summit may be required to approve any reassurances the EU may be prepared to give the UK - the next scheduled one is on 21 March, but we suspect that they will be able to schedule an emergency January meeting.

The effect on sterling

Sterling initially came under pressure after news broke on Tuesday that the 48-letter threshold had been reached, but began to rise through most of the course of Wednesday on the back of signs that the Prime Minister had enough backing. After the result was declared, it spiked up, then once again lost ground. 
If, as she promised on Wednesday night, Mrs May does stay on we expect to see sterling rally. But it is likely to be far from done on its Brexit roller coaster ride. Importantly the Prime Minister will still face the same issue that the Parliamentary arithmetic does not support the deal as it stands, while the EU is unlikely to make major concessions from here forward and probably not enough for the PM’s proposal to curry favour among enough of her MPs and the DUP. 
We expect to see sterling rally. But it is likely to be far from done on its Brexit roller coaster ride.
In the short term we suspect the pound is likely to remain volatile into the New Year, presenting a risk to our end-2018 cable forecast of $1.31. Still, we continue to judge that no-deal is unlikely and that a Brexit deal will be reached, sooner or later.
Indeed, we have for some time eyed the prospect of Parliament taking control of the Brexit process which could well lead the UK down the path of a softer more sterling-friendly EEA+ type deal. As such we continue to expect sterling to rise over a longer horizon and indeed our forecast is for cable to rally to $1.40 by end-2019.
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