Thursday 02nd May 2019

Brexit update...What is the price of a no-deal departure?

Article By Brooks Macdonald

Irrespective of our view on the progression of the Brexit process, we have prepared this short text to highlight some of our expectations for the economy and investment markets in the event that the UK undergoes a no-deal secession.

Brexit risk manifests itself in asset markets primarily through sterling exchange rates. It is clear that sterling has reacted negatively to events which have been perceived to push the UK towards a ‘hard Brexit’. As such, and in line with the post-referendum reaction in 2016, we would expect sterling to come under considerable pressure if it became clear the UK was heading for ‘no deal’.

Perhaps contrary to what one might expect, and dependent on the magnitude of sterling’s weakness, this could cause UK equities to rise in local currency terms. Large, UK-based multinationals which generally have limited exposure to the UK and generate significant proportions of their revenues in foreign currencies would outperform their smaller, more domestically-focused peers, which earn the majority of their revenues in sterling. Indeed, the latter could be among the worst performing asset classes in the event of a no-deal secession.

We would expect the domestic political scene to be thrown into disarray, noting that Parliament has repeatedly shown little appetite for a no-deal secession. This could mean the Prime Minister resigning and, potentially, a general election. Given the policy rhetoric of Labour leader Jeremy Corbyn, the risk of a general election would likely provide another headwind to sterling and potentially UK gilts, given perceptions that subsequent higher spending might damage the government’s fiscal credibility.

It is debatable how much a no-deal secession would affect the economy, but the management teams of many companies have clearly warned that there could be significant adverse impacts on their businesses. In the short and medium term, this might manifest itself in higher unemployment and lower ongoing investment. Meanwhile, it is likely that sterling’s devaluation could cause real wage growth to turn negative once more, putting additional pressure on consumption. With the global economic cycle maturing and the weakness in Europe’s key export-orientated economies showing no signs of slowing, it is certainly possible that the UK economy could enter recession.

The Bank of England would likely respond with interest rate cuts and it could restart its quantitative easing programme, as it did after the referendum. However, this might be difficult at a time when inflation is being elevated by sterling weakness. There would also be pressure on the government to loosen the purse strings to support demand and it is likely that candidates running in any general election would make manifesto pledges of higher government spending.

Conclusion

Given the many uncertainties, we have balanced our portfolios using a number of different asset classes to improve diversification and limit currency risk. Any Brexit-related sell-off might be sharp, but it could open up interesting long-term investment opportunities. As always, selectivity is key and an active investment approach will be needed to identify long-term winners.

Source: Brooks Macdonald, as at 31.03.2019.

Please note that this information is for guidance only and does not constitute personal advice.

Please note that past performance is not a reliable indicator of future performance. The value of your investment and any income from it can go down as well as up. You may not get back the amount originally invested.