With the pound sliding to two-year lows, currency markets are signaling a higher probability of a no-deal Brexit. But the fallout from no deal would hurt the rest of Europe, too, and add to downward pressure on euro-area bond yields.

Much has changed since we wrote our last Brexit update in May: the UK has a new prime minister (Boris Johnson) and a new cabinet full of Conservative members of parliament (MPs) determined to leave the EU whatever the cost. But much remains the same: Brexit is no less complicated, the government is still weak and divided, Parliament is still against a no-deal exit and the EU is still opposed to reopening the withdrawal agreement reached with Theresa May.

Focused Strategy

Boris Johnson’s strategy is clear. The rise of the Brexit Party represents an existential threat to the Conservative Party which means his overriding priority is to deliver Brexit, come what may.

He has picked a cabinet to reflect this and will hope to convince EU leaders to compromise on the Irish border backstop so that the UK can leave the EU with a deal on October 31. If this fails, Johnson is willing to leave the EU without a deal and, to this end, has ordered his government to make detailed preparations for a no-deal exit (partly so the economy is prepared; partly to show the EU that he’s serious).

There are two major snags with this strategy. First, the EU is unlikely to agree to material changes to the withdrawal agreement and Irish border backstop (especially as it thinks it is better-placed to absorb a no-deal Brexit than the UK). Second, it is far from clear that Johnson would be able to get a no-deal Brexit through Parliament (and the EU knows this, weakening his bargaining position).