A conclusion on a “Hard Brexit” - Nomura

Analysts at nomura explained that a Hard Brexit likely encourages financial institutions to consider relocating a part of their business from the UK to the EU. 

Key Quotes:

"If foreign financial institutions relocate around 20k of their UK finance jobs, or nearly 10% of their US business, we estimate around a £25bn divestment by foreign institutions is possible, which would weaken UK deficit finance further. As domestic institutions may also need to relocate, the impact could reach £50bn. Furthermore, as relocation progresses, there would be a negative impact on the service trade balance, as much of the UK service surplus comes from the financial sector. 

This could weaken the UK’s external balance by £5-10bn per year. The relocation would also weaken the UK economy via a weaker investment and employment market. If 10% of financial sector activity operated by foreign institutions is transferred from the UK, UK GDP could decline by 0.2%. Domestic institutions’ reallocation would increase the impact further, while spillover impacts on other service sectors are also possible. 

These would put downside pressure on GBP. Financial institutions may consider minimising the relocation though, as it is still unclear how significantly UK financial companies will be able to offer services in the EU. There are pros and cons for a swift relocation from the UK. The magnitude of the relocation of financial activities from the UK would be important for UK flows, not only for employment and the economy. Much of the negative news from the UK politics side is priced in the FX market. 

In the near term we think a further GBP short squeeze is possible as UK GDP could bring good news, with the BoE likely to revise up its inflation forecasts in February, and Friday’s meeting between Theresa May and Donald Trump is likely to focus on opportunities for an FTA between the US and UK. 

In the medium term though, financial institutions’ decisions could influence the trend in GBP over the next few years, and a lot rests on how the EU and UK negotiations play out and the consequent capital/labour relocations. If financial services were to implement a relocation strategy similar to our worst case scenario then we’d expect another test of Sterling’s “Hard Brexit” equilibrium of 1.18 later this year."