Why this time, Brexit really does mean Brexit
originally written by Tatton Investment Management, an investment partner of Wren Sterling
Last week’s FT headline “Brexit talks remain deadlocked” could have been printed at any point in the last four and a half years. But having sailed past deadlines, crunch talks and other ‘last gasp’ moments, negotiations are now deep into extra time. A deal would need to be ratified by the European Parliament’s last session on 14 December. Given that MEPs need time to go over the details, this week is the real deadline, and that presents a massive challenge.
Even so, capital markets have been notably sanguine. Investors do not believe – even as we race toward the cliff edge – that a no-deal Brexit is possible. Exiting the European Union (EU) empty-handed after more than four years of negotiations would be – in Boris Johnson’s own words – a massive failure of statecraft.
Despite some specific quibbles, every EU member state wants an agreement in principle, and a no-deal scenario would harm manufacturing and trade exposed areas most – an area the government would like to revive.
However, another reason UK markets look unphased is that the bad news has already been priced in. British equities have been unloved by international investors for years (even pre-Brexit vote) and there is only so much damage that Brexit uncertainties can do. British and European businesses have already been forced to make divorce plans, partly because governments have told them it is necessary, partly because the negotiating strategy of “credible threat” has, funnily enough, created a credible threat.
If businesses have already prepared for the worst, even a ‘skinny’ Brexit deal could be a small victory, a prospect that has given sterling some pep in recent weeks, but that doesn’t mean a positive outcome for the UK economy. In terms of overall economic activity, almost any deal will still see trade subject to regulatory conformity checks at the border. Even if an agreement is successfully concluded, some short-term disruption, especially to exports, remains a downside risk. The Bank of England’s latest forecast assumes disruption would reduce GDP by around 1 per cent in the first quarter of 2021, with the best hope being that the disruption will not last too long. Still, we could see higher import inflation over the short to medium-term.
The unpopularity of UK stocks over the past two years has been strongly linked to Brexit scares, but the FTSE 100 is dominated by old-industry energy companies and financials still struggling in a low-yield, COVID world. Washing away Brexit uncertainties should help – as it should the real economy. But whatever happens on 31 December, it will not be the end of market woes for the UK.