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The Threat of No Deal

By Tim Sharp, Hottinger & Co

At the time of writing investors are anxiously weighing up the chances of the UK – EU negotiators brokering a trade deal in this week’s make-or-break talks and sterling continues to be the main Brexit barometer. We seem to have had many rounds of make-or-break negotiations, but most people would agree that time is now close to running out for a trade deal to be ratified by the 31st December 2020 deadline.

On Tuesday, Boris Johnson’s government pulled parts of the Internal Markets Bill that breached the existing Withdrawal Agreement. This followed a separate deal brokered by Cabinet Office Minister, Michael Gove, and EU Commission vice-president, Maros Sefcovic, regarding the implementation of the Northern Ireland protocol. The move was supposed to be seen as a grand gesture that signaled the UK’s willingness to compromise on the outstanding issues. Nevertheless, an impasse has led to Johnson himself joining his negotiating team in Brussels for the final push, arranging dinner with EU President Ursula von der Leyen for tonight.

It is no secret that the results of the talks this month could be instrumental in deciding the UK economy’s path to recovery and the monetary and fiscal policies that will need to be employed. Back in May it became obvious that the central bankers of the major economies were considering the potential effects of implementing negative interest rates based on the experiences in Europe. In the UK, the Bank of England (BOE) Governor, Andrew Bailey, originally felt it necessary to be quoted suggesting that he was not contemplating such a move, before stating that negative interest rates could not be ruled out. The increase in sterling volatility has been attributed to investor fears that a no-deal could see the UK’s economic contraction worsen and could lead to the introduction of a negative interest rate policy by the UK central bank.

In its latest Economic Outlook Report in November, the OECD forecasts the outlook for the UK to be the second worst amongst the 20 largest national economies, including the eurozone, except Argentina. The UK is expected to still be 6% below its 4th quarter 2019 position by the end of 2021 having contracted 11.2% in 2020 and only forecast to grow 4.2% in 2021. In its assessment the OECD considered the UK economy to be at a “critical juncture” with Brexit, cited as the biggest downside risk to its forecast.[i]

The UK Government’s independent spending watchdog the Office of Budget Responsibility released a report in November that stated that “no deal” was a “material risk” that would reduce UK GDP growth in 2021 by 2% as well as push unemployment over 8%. Their forecast for 2021 economic growth would, therefore, fall to 3.5% following temporary disruption to cross-border trade. In its main forecast the UK economy returns to its pre-crisis level by the end of 2022 but in a case with no negotiated EU trade deal, this would be pushed out to the end of 2023[ii]. Furthermore, the BOE has warned that the transition to new arrangements will see UK GDP cut by 1% in the first quarter of 2021, and it is estimated that only 70% of companies are ready for the changes.[iii]

For those who harbour a mistrust of forecasters and statisticians perhaps the view of equity investors may provide an alternative view on the outlook for the UK under new arrangements. Year-to-date, the S&P500 index in the US is up 14.50%; Japan’s Nikkei 225 is also up 13.36%; the Shanghai Composite Index is +10.55%; the German DAX is up 1.31%; the SMI Swiss index is down 1.58%; Italy’s MIB index is -5.88%; in France the CAC40 is down 6.42%; while the FTSE All-Share index is down 11.3%. Clearly, investors believe that the effects of a no-deal will hang heavier on the UK than its European counterparts and have allocated away from the UK stock market despite the international bearing of the Top 100 companies.

Karen Ward, chief market strategist, EMEA, JPMorgan Asset Management, believes that sterling would fall by 10% in trade-weighted terms in the event of no-deal, and it is assumed that the value of repatriated overseas earnings, therefore, rises. As 77% of FTSE 100 revenues are earned abroad then, by definition, the value of the FTSE 100 index should appreciate, and many money managers are recommending favouring blue-chip companies with significant overseas earnings in the event of a no-deal[iv].

However, Karen Ward points out that over the past 10 years the relationship between index returns and trade-weighted sterling has had an average correlation of close to zero and sometimes negative[v]. 40% of FTSE 100 revenues come from Europe, 27% from the US and 30% from Asia and Emerging Markets, and the index is disproportionately weighted towards financials and resources. Therefore, any effect on global sentiment from the breakdown of talks that leads to the protraction of global economic weakness could be the worst-case scenario for the UK’s main index.

However, in the light of vaccine optimism we have witnessed the beginnings of a rotation away from technology and healthcare sectors into sectors that will benefit from the re-opening of global economies such as consumer cyclicals and consumer discretionary. The FTSE 100 index has a number of dynamic consumer goods companies with global revenue streams and brand loyalty that have proven resilient in a changing environment, and, in our opinion, should continue to do so.

Despite the optimism of the most fervent Brexiteers we hope that the negotiators can over-come the remaining hurdles at a time of great flux, for the greater benefit of economies and markets alike.


[i] https://www.theguardian.com/business/2020/dec/01/government-covid-oecd-uk-growth-forecast


[ii] https://www.independent.co.uk/news/uk/politics/brexit-no-deal-uk-economy-boris-johnson-b1761709.html


[iii] https://uk.finance.yahoo.com/news/bank-of-england-monetary-policy-report-brexit-impact-uk-economy-094922126.html?guccounter=1




[iv] https://www.thisismoney.co.uk/money/investing/article-8994163/MR-MONEY-MAKER-Deal-no-deal-Brexit-strong-ramifications.html

[v] https://www.ft.com/content/1964afce-f4c5-49dc-86c4-95b62fbf46bf

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