Brexit – the final approach

As the official exit date draws near, what economic and market impacts are being anticipated?

“When the facts change, I change my mind. What do you do, Sir?” John Maynard Keynes is supposed to have said.

Even if he didn’t, the words offer a useful reminder that investors must always be willing to question their assumptions. For those contemplating the implications of the UK’s impending exit from the EU, however, the problem is that the political facts seem to change by the week – sometimes by the day.

So it is worth turning occasionally to broader economic trends, which can offer clearer – or at least less changeable – signals.

• This week, it emerged that the Purchasing Managers’ Index for the services sector, which accounts for around four fifths of UK GDP, slipped in January to a two-and-a-half year low of 50.1 (where a straight 50 indicates neither improvement nor deterioration).1
• Business investment in the UK contracted through the latest three quarters for which data have been released.2
• The economic growth rate has halved since 2014, but employment remains resilient.3 

Yet even on these counts we run into trouble drawing clear conclusions. While there has been a slowdown, the UK has not slipped into recession. Declining business investment could be merely temporary, as the contours of Brexit remain undefined. In fact, the biggest question hanging over the data may be over how immediate its causes are. In other words, is the current slowdown merely a factor of pre-Brexit uncertainty or does it reflect the fact of Brexit itself?

Brexit and growth: odds and opportunity

Recent odds suggest that a delay to Brexit is eminently possible. Capital Economics placed the chances of a “fudge and delay” Brexit at 55%, versus 30% for a no-deal exit on that date and 15% for an exit with a deal on the same date.4 Anatole Kaletsky of Gavekal, an investment research house, argues that a no-deal Brexit remains possible but not probable: “In reality, the chances of ‘no deal’ are no higher today than they were a week ago, since there are increasing signs that the EU and the Labour Party are yielding to May’s pressure and will offer the concessions she demands for a negotiated Brexit to go ahead.”5

What about growth? Has the pain already been felt amid all the uncertainty or is the recent slowdown merely a first instalment of what lies ahead when the UK truly exits the EU? Bloomberg projections show that a UK–EU exit deal would enable a pick-up in growth due to a fiscal expansion, a boost to incomes via a rising pound, and more certainty about the future. (The latter would presumably boost business investment, too.) It argues that a three-month delay to Brexit would cost the economy 0.2% in annual GDP growth, versus 0.6% for a six-month delay.6

Looking further ahead, Capital Economics forecasts that a deal-based Brexit could spur the UK to be the fastest-growing economy in the G7 in the year 2020; making up somewhat for having missed out on the synchronised global upturn of 2017–18. It notes that, while the UK economy has moved in line with the US and EU (or EEC) 70% of the time since the 1960s, it has gone in a different direction from them both 15% of the time. It sees capacity for business investment to bounce back, offering a potential economic boost of 0.5% GDP growth over the coming two years.7

“Brexit is a political risk, not an economic one,” it argues in a recent report. “While the uncertainty caused by Brexit has clearly hampered investment and consumption, the economy is fundamentally sound and its foundations will probably strengthen over the next year or two.”

Lost growth, new growth

Nevertheless, Treasury forecasts suggest lost growth in all Brexit scenarios. EEA membership (the 'Norway option', providing access to the Single Market) would cost the UK economy four percentage points of growth over the coming years; a negotiated bilateral deal would mean more than six points lost; and a no-deal exit would mean more than seven points forfeited.8

Prior to EEC entry, the UK was known as the ‘sick man of Europe’. More pointedly, Gavekal’s Anatole Kaletsky suggests that a lasting surge in UK economic performance – measured in GDP per capita terms – didn’t take place until the UK joined the Single Market in 1993. On this basis, leaving it could have significant negative potential.

Even without a hard Brexit, Kaletsky believes sterling and the euro could fall some way if Brexit goes ahead. On the other hand, Société Générale, a leading French bank, sees huge potential upside in sterling – a rise to $1.40 in the case of what it calls a “sensible” Brexit, or above $1.50 if Brexit is cancelled.9

Sterling has been the most immediate conduit of Brexit news on financial markets, but commercial property has not lagged far behind. All the same, the impact was far from uniform across the asset class – and such differentiation may well continue.

“Segments of the commercial property market seem more at risk from Brexit – like the City of London, with the potential exodus of large financial institutions to cities such as Paris,” said Philip Gadsden of Orchard Street, manager of the St. James’s Place Property fund. “It is possible that in the next year to 18 months, we will see people wanting to sell off assets quickly – in which case, our cash balance means we are primed to benefit. Moreover, the uncertainties have led many developers to hold back from further building projects, and that lack of pipeline newbuilds means there is potential for rapid rental growth in the coming two to three years,” says Gadsden.

Brexit impact v. global impact

While few economists expect Brexit to have a major impact on economies beyond the UK and EU, the reverse is not true: global growth trends will still have enormous influence on the direction of the post-Brexit UK economy. Capital Economics sees a global slowdown already under way, but believes its impact in the UK would be mitigated by an exit deal, as business investment picks up.

Kaletsky argues that investors are yet to price in the most likely outcome – Brexit via a tweaked version of Theresa May’s deal. One route to this outcome, he argues, would be for the EU to unilaterally extend the deadline. “If European leaders had the gumption to take this step, sterling and British domestic asset prices would really take off – and assets in other European countries might find some badly needed support,” said Anatole Kaletsky.

Investors tempted to flee UK assets should bear this potential recovery in mind. And yet in the current political climate, leaving all your investments in UK-focused assets could make you vulnerable. Unless you know something that we – and the politicians – don’t, it’s best to be prepared for all scenarios, and diversify your holdings. Whatever your personal view on Brexit and how it will turn out, there’s no need for your assets to be reliant on any one particular outcome.

Orchard Street is a fund manager for St. James’s Place.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The opinions expressed are those of Anatole Kaletsky of Gavekal, Capital Economics and Orchard Street and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or adopt a strategy. The views are not necessarily shared by other investment managers or St. James’s Place Wealth Management.

1 Source: Bloomberg

2 Source: Trading Economics.com 

3 Source: Office for National Statistics

4 Source: Capital Economics

5 Source: Gavekal Research

6 Source: Bloomberg Economics

7 Source: Capital Economics

8 Source: HM Treasury

9 Source: The Pound Live