INSIGHTS BLOG

BIG WEEK FOR BREXIT NEGOTIATIONS

Mark Lister, 12 March 2019

This week is a crucial one for Brexit developments, with multiple votes in the UK parliament likely to take place.

Britain is scheduled to leave the European Union (EU) on Friday 29 March, but with the latest deal voted down by the UK parliament, there’s a reasonable chance we see the current deadline extended.

While this might buy both parties a little more time, it will only delay the inevitable. Neither the UK or the EU will want any extension to go beyond June, as the UK would then be forced to take part in elections for the new European Parliament.

Detail around the “Irish backstop” remains a key area of debate. The UK want to make sure there will never be a physical border in the middle of Ireland (between the Republic of Ireland, which is staying in the EU, and UK-ruled Northern Ireland, which is leaving with the rest of the UK).

The next EU summit takes place next week, where the EU was hoping to formally sign off the UK’s departure. With negotiations dragging on, there’s a reasonable chance we see the current 29 March deadline extended.

All of this uncertainty has weighed on the UK economy, sharemarket and the British pound since the Brexit referendum took place in the middle of 2016.

The economic and social impacts of Brexit are hard to predict, and will take some time to play out. However, for financial markets it boils down to one key question – does the UK leave the EU with a deal in place, or not?

Having an agreement in place to tackle the mechanics of the transition is the preferred outcome, while the arrival of 29 March without anything in place would represent a fairly ugly scenario for the UK.

The Bank of England estimates this would lead to a hefty fall in economic output, with equally detrimental declines in employment, house prices and the currency.

Given the dysfunction we are seeing at a political level; markets are not ignoring the prospect of such an outcome. Consequently, the UK sharemarket and the pound remain unloved.

UK share prices are down slightly over the past two years, compared with the rest of the world, which has gained about 20 per cent. Meanwhile, the pound is almost 25 per cent below its 25-year average against the NZ dollar.

For those willing to go against the herd, this could represent an opportunity. If the British parliament could agree on a deal of some sort, first between themselves and then with the EU, the clouds of uncertainty would start to clear.

The associated sigh of relief would improve the short-term outlook for the British economy, lifting asset prices and boosting the pound. It would also clear the way for the Bank of England to raise interest rates slightly, as these have been held artificially low on the back Brexit uncertainty.

This would be a good outcome for some New Zealand exporters. Less than three per cent of our total goods and services end up in the UK these days, but for a handful of sectors the UK remains a very important market.

Investors holding UK shares would also benefit, including the many New Zealanders who still have pension funds from their days in London.

Ironically, a deal wouldn’t be as positive you might think for the most widely followed sharemarket index in the UK, the FTSE 100.

Many of the largest UK companies are multinationals that derive a significant proportion of their earnings from outside the UK. A stronger pound is actually a negative for these export driven businesses, and positive news on the Brexit front may not do their share price any favours.

Investors who want to bet on a ‘Brexit bounce’ would be better served looking at smaller UK companies, as well as real estate assets. These are more exposed to the domestic economy, and therefore stand to benefit to a much greater degree.

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