Going it alone
As the UK reinvents itself as an independent sovereign state – but with an EU trade agreement in place – just what will this mean for business, investment and the wider economy in both markets? Here BNY Mellon Investment Management firms share their thoughts.
An over 47-year journey for the United Kingdom’s engagement with the European Union (EU) is finally ending. What started with the UK becoming a fully-fledged member of the European Economic Community (EEC) under then Conservative Prime Minister Edward Heath in 1973, ends in 2021 under another Conservative Prime Minister, Boris Johnson.
It has been quite a trip. Along the way referenda in 1975 and 2016 saw the UK separately vote to remain within the EEC and then leave its successor, the EU, in one of the biggest political upsets in recent European history (see ‘Full circle?’ commentary below).
Now, as the UK leaves the EU Brexit transition period, having secured an 11th hour mutual trade agreement, the question is: where will the latest changes leave the UK and businesses and investors that operate within its borders and beyond?
UK exports to the EU may take at least some hit but appear to have been spared the worst aspects of a ‘no deal’ trade arrangement. Recent UK exports to the EU accounted for 43% of all UK exports and imports from the EU accounted for about 52% of all UK imports. Therefore, trading under World Trade Organisation terms could well have seen a range of new tariffs imposed.¹
According to forecasts from Britain’s Office for Budget Responsibility (OBR) a no-trade deal could also have wiped an extra 2% off British economic output in 2021 while potentially driving up inflation, unemployment and public borrowing.² Accordingly, this threat has also now receded.
Brexit: eleventh hour trade deal
Allows for some continuity on trade of goods. Less clear for services
Considered broadly positive for equity and bond markets
Pricing and inflationary pressures from Brexit unlikely to be as severe as under ‘no deal’
Non-tariff barriers could still apply without single market/customs union membership
Thin trade deal far from the comprehensive deal initially sought
Position on services/financial services treatment still unclear
With a trade deal likely to spare the UK from the worst of these impacts, BNY Mellon investment Management chief economist Shamik Dhar, sees some firm grounds for optimism.
“I am more optimistic than most that neither Brexit nor the Covid-19 pandemic will result in long-lasting scars for the UK economy. I believe many of the more negative estimates depend on Brexit being a substantial hit to productivity growth, which is highly speculative.
“Now we have the certainty of a “clean” deal, UK businesses can return to focusing on generating productivity in the longer term. Developments in technology mean we might also be on the cusp of a productivity upturn and, to an extent that is largely independent of the Brexit outcome.”
Others are less optimistic about the immediate Brexit outcome. According to Insight fixed income investment specialist April LaRusse at least some shockwaves are likely to be felt in both the UK and EU in 2021. “With a deep and comprehensive free trade agreement out of reach, a range of estimates suggest this “bare bones” deal could detract 4-7% from UK GDP in the long run,” she says.
“Our UK economic forecast for 2021 will assume a 3% hit to GDP from Brexit, given the agreement reached. For the Eurozone we expect roughly a quarter of this impact overall, but with significant variation between countries.”
Bond and equity impacts
Newton fixed income portfolio manager Howard Cunningham says: “The fact we have a deal should help arrest the recent falling value of sterling and the reduction in 10-year gilt yield and should pose less of a threat on inflation. That said, at best we are looking at quite a thin trade deal which may present business bottlenecks and non-tariff issues to deal with – and all against a backdrop of the on-going Covid-19 pandemic.”
Mellon economist Rowena Geraghty also fears greater bureaucracy could damage trade outcomes for some UK and European companies.
“While the ‘skinny’ trade deal we have agreed eliminates the need for tariffs it does not eliminate non-tariff measures applied to goods. Under the agreed deal we still expect more customs forms to be filled out and the potential for delays at ports,” she says.
Assessing the business sectors most likely to suffer under existing Brexit terms, Geraghty adds: “There could also be repercussions for both the services and financial services sector. It is worth noting both these sectors contribute far more to the UK economy than, say, car manufacturing.”
Equity markets are likely to take the news of a deal positively, according to Newton global equity portfolio manager Paul Markham. That said, he adds: “It is quite a thin deal, is not comprehensive and the markets’ initial reaction is likely to be one of relief without delivering the boost we might have seen from a more comprehensive deal. Either way, we may see a short term bounce for some UK domestic assets; and financials might do well – as might homebuilders and UK cyclicals.”
Markham’s multi-asset colleague Paul Flood believes striking a UK/EU trade deal was in everybody’s interest and should now allow businesses to focus on the future. “Taking no-deal out of the equation is a net positive for the UK,” he adds.
From an equity market perspective Flood is hopeful Brexit could ultimately yield some other positives. “On a long-term basis UK assets do look cheap. Despite all the disruption we have seen, international investors could look at the UK for opportunities again, given time. Against this backdrop, the UK banking sector is just one area that could benefit from greater certainty as well as many other businesses that could benefit from the opportunities presented as the UK opens up to dealing with new partners,” he adds.
Looking ahead, other portfolio managers have mixed views on Brexit’s eventual outcome. For Newton’s Cunningham, market certainty should provide grounds for at least some stability.
“Certainty versus uncertainty is important. At least now we have some business certainty and investors can plan ahead. Whatever the political view, a large part of the UK population thinks Brexit is a good idea and will still go out and spend. There will still likely be some disruption in the short-term, due to non-tariff barriers to trade. Furthermore, large and important parts of the economy (the service sectors) are not included in a ‘trade’ deal, but we should be able to reconfigure the economy over time,” he says.
After the UK’s often fraught departure for the EU, some commentators question whether any other member states will choose to follow. For Markham, the political capital depleted by Brexit negotiations makes this highly unlikely in the short term.
“It could be argued the EU has taken an approach to Brexit that has at times heightened UK discomfort with arrangements in a way that would most likely discourage any other country from following its stance in leaving the Union. At this stage it does look likely this will dissuade others from following suit,” he concludes.
Full circle? The UK, the EEC and the EU departure
The UK’s political engagement with Europe has divided public opinion for decades. Fears about the emergence of a European super state and loss of sovereign control had long haunted wings of both the UK’s ruling Conservative and Labour Parties before Brexit.
Entry into the EEC or Common Market was seen as proud achievement by the then Heath government, but proved controversial and was closely followed by a referendum on membership under the Labour government of Harold Wilson in 1975. At that point the UK voted to remain by some margin.
Yet, amid what some saw as growing mission creep by European institutions, opposition to the UK’s EEC/EU membership grew steadily, backed by an often hostile British press. Economic events would give EU critics future ammunition to attack the union and the UK’s wider integration with Europe.
The so-called Black Wednesday debacle in 1992 saw the then Conservative Government of John Major forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM) as its value went into freefall. This followed a failed attempt to keep the pound above the lower currency exchange limit mandated by the ERM and was seen by some as yet another European misstep in a project the UK appeared ill suited to.
Keeping pace with the ERM had been part of wider European efforts towards creating a single European currency. In fact the UK never joined the emergent Euro currency. The multi-year European sovereign debt crisis that first flared in 2008 also triggered further UK doubts about the EU.
In 2016, amid growing opposition to EU membership and immigration concerns surrounding its freedom of movement rules, a knife edge referendum vote favoured the UK’s departure. While the UK officially left the EU in January 2020, January 2021 signals the UK’s final departure from a residual 11 month EU Brexit transition period.
¹ House of Commons Library. Statistics on UK-EU trade (2019 figures quoted). 10 November 2020.
² OBR/Reuters. Explainer: The potential impact of Brexit without a trade deal. 07 December 2020.