HOW WILL NEGOTIATIONS AFFECT INVESTMENTS

What next for Brexit?

  • 17 June 2020
  • 10 mins reading time

We conducted a webinar chat for clients last week. The topic of conversation, “What next for Brexit?” was suggested by clients. In this briefing we’ll summarise the discussion and answer a couple of questions that we didn’t have time to address during the webinar.

Is Brexit still relevant after Covid-19?

The first question we addressed was whether Brexit still matters after the fall-out from the battle against Covid-19. The short answer as we see it is emphatically “yes”.

So let’s explain.

No one can say for certain what the outcome and consequences of Brexit will be. But we have to start somewhere, so we looked at an in-depth report from the London School of Economics which showed a worst-case scenario of the UK economy losing out on 8.1%-worth of growth over the next 10 years in the event of a hard Brexit[1].

This chimed with the government’s own leaked “EU Exit Analysis – Cross Whitehall Briefing” from 2018, which predicted an 8% loss of growth over 15 years in the event of a no-deal outcome[2].

Meanwhile, the projected decline in the UK’s economy in the short-term as a result of Covid-19 is 7.9% according to Bloomberg[3] data. The data we’re looking at indicate that a good deal of fall in demand could return when the contagion abates or a treatment is found. Many people still want to buy holidays, cars and restaurant meals, for example. This supports our anticipation of a global economic recovery gathering steam in 2021.

The UK’s situation relative to the European Union (EU) is different. It concerns almost half of the UK’s exports and more than half of the country’s imports. The UK is a net exporter of services, that is to say, it sells more to the EU in sectors such as finance and tourism than it buys from the EU. Any loss of this trade would take longer and a more complicated process to replace than is the case with Covid-related losses.

What are the problems with WTO trade rules?

A hard Brexit would leave the UK depending on World Trade Organisation (WTO) rules. There are some challenges here. For example, WTO rules are primarily designed for goods rather than services, and the organisation’s legitimacy is under pressure after President Trump threatened to withdraw the US from the WTO. Even assuming that the WTO remains intact and can provide oversight for all of the UK’s imports and exports, there remains the question of “most favoured nation” status.

The current UK government has indicated that it would like to retain preferential trade terms with the EU. To do so under the WTO’s rules would require that the UK pass legislation confirming the EU as its most favoured nation in terms of trade.

Failure to do so would leave the UK having to offer the exact same trade terms to all other nations. Having been a member of the EU, the UK does not have this legislation in place yet. This ought to be a relatively straight-forward process, but it is dependent on the UK and the EU agreeing terms.

The sticking points between the UK and EU include access to fishing areas, movement of labour, finance industry trading terms, as well as health and safety regulations. And that brings us back to the timelines.

Is the UK public against a further extension?

To agree all of those points, iron out the legalese and pass the legislation between now and 31 December is, to say the least, ambitious. In the meantime, Prime Minister Johnson has to discern what the voting public wants.

According to a recent poll[4] conducted by Savanta: ComRes on behalf of the pro-Brexit organisation, Centre for Brexit Policy, “The public wants the government to either shorten the transition period or stick to its current timetable by a small margin (44% to 40%)”. But this comes with the significant caveat pointed out by the independent fact checking charity, Full Fact, that participants in the poll “agreed to pretty much every question that was put to them, regardless of whether it implied support or opposition to extending the transition period”[5].

With such a close call, it might not be a surprise to see some sort of delay in all but name that enables Mr. Johnson to save face while also allowing a more realistic timeframe for the mammoth task that looms over his civil servants.

This leads us to a question that we did not have time to address during the webinar.

What does the UK pay to the EU at the moment?

The UK continues to make its annual payments to the EU during the transition period. The actual figures are released in July for the preceding calendar year. The most recent data, therefore, apply to 2018 during which the UK made a net contribution of £11 billion across the entire year according to the Office for National Statistics[6]. The additional one-off outstanding commitments that the UK assumed while being a member of the EU are a matter for negotiation, total bill could be around £33 billion[7].

One has to compare this with the total UK government expenditure in 2018 of £865 billion (from the same ONS report) and the £648 billion of trade conducted between the UK and the EU in the same year according to the House of Commons Library’s “Statistics on UK-EU trade” published on 16 December 2019. For some it’s a ticket to trade, for others it’s too high a price.

Which regions will be most affected by Brexit?

This is another question that we didn’t have time to answer. In the case of a soft Brexit, the effect could be minimal, enabling trade to continue with relatively little impediment. However, if we were to experience a hard Brexit, the government’s “EU Exit Analysis – Cross Whitehall Briefing”, referenced earlier in this blog, noted that the Northeast and the Northwest of England, the Midlands and Northern Ireland could suffer the biggest losses of economic growth to the tune of 12% or more because of the nature of the industries that dominate there being more vulnerable to a loss of EU business. Like most things to do with Brexit, these are projections and, as such, open to debate.

What can we predict about Brexit?

Two things. Firstly, Brexit is very likely to be back in the headlines over the coming weeks with an unhelpful degree of sensationalism. One of the consequences we expect from this is more turbulence in asset prices.

Secondly, we foresee the pound acting as a pressure valve. Demand and prices have already fallen as a result of Covid-19. Interest rates are unlikely to be raised any time soon and the additional uncertainty of Brexit has reduced confidence in the economic outlook for the UK. If there’s less confidence in the UK’s future, and low interest rates offering little return on cash, then investors and traders are more likely to change their pounds into other currencies.

Add to that the increased electronic printing of money by the Bank of England (in the form of quantitative easing i.e. creating money on its own account and using it to buy bonds in the open market), and it seems reasonable to expect the value of the pound to fall further relative to other currencies. This could be good for UK exports, but it would be equally likely to push up the prices of imports.

We’re certain of uncertainty

Unfortunately, then, the near-term outlook is one of turbulence and uncertainty.

Investors will have to keep cool heads as newspapers parade worrying headlines, and negotiations continue between the UK and the EU. The one positive point that we can offer is that of the UK’s capacity to endure difficult situations: over the long term of around 10 years or more, we have confidence that the UK economy will be back on a more secure footing with a clearer outlook.

[1] “Economic consequences of Brexit are overwhelmingly negative”, London School of Economics, 26 November 2019 [2] “This leaked government Brexit analysis says the UK will be worse off in every scenario”, BuzzFeed.com, 29 January 2018. [3] “UK Chained GDP at Market Prices QoQ”, sourced from Bloomberg 3 June 2020. [4] Poll commissioned by the Centre for Brexit Policy, a pro-Brexit organisation, asking about respondents’ preference for a longer, shorter or unchanged transition period for the UK’s departure from the EU, published 4 May 2020. [5] “Claim that extending the Brexit transition period could cost £380 billion is not credible”, Fullfact.org, 4 June 2020. [6] “The UK contribution to the EU budget”, Office for National Statistics, 30 September 2019. [7] “Brexit: the financial settlement detail”, House of Commons Library, 16 March 2020

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Forecasts of future performance are not a reliable guide to actual results in the future; neither is past performance a reliable indicator of future results. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed and the investor might not get back their initial investment,

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