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.
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.
“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 tghe 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.