For once, the polls were dead accurate. Boris Johnson won the contest to become the leader of the Conservative Party with two thirds of the vote, pretty much exactly what pollsters had predicted. This means that BoJo will become the next Prime Minister of the UK. I have covered my views on the new Prime Ministers character flaws earlier today, so let’s focus on the possible way forward.
Boris Johnson is clearly not the most popular member of his party and several centrist MPs have already announced that they are unwilling to serve in his cabinet. Thus, Boris Johnson’s selection for crucial cabinet posts will indicate the policy direction of his government. It seems likely that a hard Brexiteer will become Brexit secretary. We could potentially see the return of Dominic Raab, but other cheerleaders of Boris like Iain Duncan Smith would also be plausible candidates.
However, in my view the most important position to watch will be the Chancellor of the Exchequer. Traditionally, this role is given to someone of a different policy persuasion than the Prime Minister to appease different factions within the party. A more moderate candidate like Liz Truss or Sajid David would be a signal to the centrist MPs that Boris is willing to compromise on Brexit and aim for a softer Brexit that is closer to the deal Theresa May proposed already. A hard line Brexiteer like Dominic Raab or someone from the European Research Group (God help us if it is Jacob Rees-Mogg) would be a clear signal that Boris is trying to move the party to the right in order to undercut the Brexit Party’s appeal at the Tory base. Such a move would indicate to me that Boris is speculating that he will either get a hard Brexit or head to a snap election in which he would try to campaign on a hard Brexit or some other form of quick exit from the EU.
Which brings me to the way policy options for the new government. And in short, there are no good options. After promising the world to his voters, Boris now has to deliver.
Option 1: Hard Brexit
Despite his campaign promises, a hard Brexit seems unlikely to me. There is no Parliamentary majority for a hard Brexit and several Tory MPs have already indicated they would rather bring down the government and trigger a snap election than a allow a hard Brexit to happen. With the passage of several amendments to the Northern Ireland Bills last week, it is also almost impossible to prorogue Parliament to avoid this scenario. Also, activist Gina Miller has already started legal action to prevent the government from circumventing Parliament. Thus, while I think that with the new Prime Minister there is an increased chance of a hard Brexit, it still has a low likelihood in the range of 10% to 15%.
Option 2: Second referendum
A second referendum on Brexit would be a neat way out of the miserable situation the government is in, but let’s face it, Boris would be hanged and quartered by his constituents if he ever agreed to that. Thus, the chances of a second referendum in my view have declined significantly for now and are about the same as for a hard Brexit: 10% to 15%.
Option 3: A deal, any deal, anything that resembles a deal, really…
If Boris Johnson wants to survive more than a few months as Prime Minister and preserve the union, he has to come up with a Brexit deal that is sufficiently soft to get centrist MPs from his own party on board as well as the MPs form the DUP or some Labour MPs from leave-voting constituencies. The problem is that two such deals exist. It is a) Theresa May’s deal or b) a deal consisting of a transition period followed by a customs union for goods with the EU.
And this exactly Boris’ problem. Both deals need to be made palatable to the hard Brexit faction in his own party. Thus, Boris and his government have to go back to Brussels and try to get some nominal changes to the existing deal that allows them to sell it as a “win” and major “concessions” by Brussels. In my view, this is a walk on a tightrope but the most likely outcome and the best way forward for the new Prime Minister. The problems are twofold, however. First, the EU has no incentive to renegotiate the existing proposal and any renegotiation would likely lead to another extension of the Brexit deadline beyond 31 October. Boris Johnson will not want to extend the Brexit deadline but he might have to swallow this toad. In my view this is the most likely outcome and I would put a likelihood of 30% to 40%on this option.
Option 4: Snap election (because it has become our national pastime to vote)
Instead of a second referendum, we could head for a snap election that is fought over the Brexit issue and thus acts as a surrogate referendum. A snap election could either be triggered by a successful vote of no confidence in the new government or by the government itself, if Boris thinks that he can win a Parliamentary majority by shifting the Conservative Party to the right of the political spectrum and enticing Brexit Party voters to stick with the Tories. Both these scenarios are quite likely in my opinion (30% to 40%), but they have two major obstacles to overcome.
First, it would almost inevitably lead to an extension of the Brexit deadline, which, I think, the EU would be willing to grant in this case, just to get rid of Boris and his government. Second, the likely outcome of a snap election would be another hung Parliament. A recent YouGov poll of voting intentions if Boris Johnson became Prime Minister shows that a snap election would likely produce a very splintered electoral result (see chart below). Neither of the two large parties would likely come close to the absolute majority and depending on the outcome, we would either face a coalition government of the Conservative Party with the Brexit Party or a coalition of Labour with the LibDems and the SNP.
In the case of a Conservative/Brexit Party coalition we would almost inevitably face another independence referendum in Scotland and Boris Johnson could go down in history as the Prime Minister who oversaw the end of the Union. In the case of a centre-left coalition we would have to deal with a Prime Minister Jeremy Corbyn (albeit kept in check in his policies by the LibDems and the SNP)…
Market implications: Buy Sterling
In my view, Sterling has priced in a lot of the hard Brexit risk already and if anything, I would expect Sterling to strengthen from here on as we are facing either a softer Brexit than expected or an extension of the Brexit deadline. This should also be good for UK small- and mid-caps but bad for export-oriented large caps. The Bank of England will obviously stay on the sidelines for the rest of the year and wait for some resolution of our current political mess.
Voting intentions if Boris Johnson becomes Prime Minister