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Article 50: The Brexit Paradox

Britain’s exit from the EU (Brexit) began yesterday when PM Theresa May triggered Article 50 of the Lisbon Treaty. Here we assess briefly the impact under three headings – politics, economics and markets.

Politics – The Brexit Paradox. Much has been settled since 23rd June last year. We have a new Prime Minister in Theresa May and we know the teams involved. The two key politicians will be David Davis for the UK and Michel Barnier for the EU. The key officials will be Oliver Robbins and Sabine Weyand.

Encouragingly, it seems there will be proper scrutiny by the UK parliament. Keir Starmer and Hilary Benn are stepping into the vacuum left by Jeremy Corbyn to ask the government difficult questions.

However, Daniel Finkelstein in yesterday’s Times outlined the Brexit paradox. He wrote that if we insist on being winners, we are bound to be losers. He meant that Britain leaving the EU cannot look like a good deal to the rest of Europe. That would be a recipe for the EU to fall apart, which Brussels, Berlin and Paris will resist at all costs.

But a bad deal for the UK in Brussels must look like a good deal to British voters. After all, a general election is due about a year after Brexit. Both sides are now doing their best to talk up areas of mutual benefit but the Brexit paradox could yet get in the way.

Economics – Minimising The Downside. Since the vote to leave, the UK economy has been remarkably resilient. Economic growth was 0.6% in the third quarter and 0.7% in the fourth.

However, the upturn in inflation is squeezing real incomes and so consumer spending should slow. On the other hand, investment intentions have recovered after a tumble and exporters will benefit from a weaker pound. Overall, we expect a slowdown but not a recession in 2017 and 2018.

The two-year timeframe for Article 50 negotiations could be important. Spending plans may be put on hold awaiting the outcome which could hurt the economy. Conversely, there could be a growth spurt in late 2018 or early 2019 if the conclusion is favourable.

Over the long term, though – say ten or twenty years – we cannot see an alternative to slower growth and higher inflation than otherwise. Unfortunately, we shall never know because we do not have a parallel universe where we remain in the EU. But Britain will lose easy access to a market of 445 million consumers and roughly US$18trn GDP a year. Overwhelming research shows that size and distance matter in trade relations and this very large market is on our doorstep.

Markets – How Much Is Priced In? The arbiter of Brexit was always the pound and not the UK stock market. Since 23rd June, sterling’s trade-weighted value has fallen by just over 12%.

Markets always discount today the expected future tomorrow. If the Brexit talks go well, then the pound may appreciate. If they don’t, it may weaken. We cannot offer much guidance. However, the negotiations will hit tough patches so expect spells of turbulence.

Turning to the stock and bond markets, leaving the EU is a highly uncertain exercise. Markets hate uncertainty so expect jittery trading. For choice, we expect Brexit to tilt the balance in favour of gilts relative to equities. Both asset classes may struggle to make strong returns from here.

Our investment strategy committee, which consists of seasoned strategists and investment managers, meets regularly to review asset allocation, geographical spread, sector preferences and key global market drivers and our economist produces research and views on global economies which complement this process.

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