UK election result and what it means for Brexit
The Conservative Party won a working majority at the UK general election yesterday. After months of parliamentary deadlock, Prime Minister (PM) Boris Johnson, will focus on getting his Withdrawal Agreement Bill (WAB) ratified by Parliament in order for the UK to leave the EU on 31 January 2020.
The UK then enters a transition period where Johnson hopes to negotiate a trade deal with the EU by the end of 2020.
What does this mean for the UK economy?
As we discuss in our Brexit article in the Outlook 2020 uncertainty has been difficult for domestic business investment and the impact to productivity has started to show its teeth in the employment data. Indeed, the August and September readings indicated falling employment numbers and vacancies continuing to fall.
Assuming the WAB is passed with little amendment, a no-deal EU departure moves further off the table, especially in the early stages of the transition period.
The remoter possibility of a no-deal would likely reassure UK business and help realise some pent up business investment. This, combined with any fiscal easing, will aid both investment and demand. Although, it is worth acknowledging, as Bank of the England Governor Mark Carney has, that not all business investment will come back.
Much will depend on the government’s approach to the future relationship negotiations and the prime minister’s current tight timetable to formalise a trade deal with the EU by the end of 2020. Trade deals of this nature on average take around four to five years.
If an extension to the transition period is to be sought, it likely needs to be done by the summer of 2020. It is possible that cliff-edge no-deal departure fears, that have often dogged financial markets since 2016, could happen again.
What asset classes appear most attractive?
Next year is likely to unfold initially as a rosier picture for the UK economy, aided by more certainty, before a more ambiguous outlook emerges as we move further to the transition deadline.
This is something the Bank of England (BOE) acknowledged in its November monetary policy report, which provides economic estimates based on the deal agreed between the UK and the EU and the Conservatives’ proposed transition timeline. During this period, the BOE’s forecast for inflation remains below the 2.0% target.
In light of this, in our view the BOE will seek to avoid a policy mistake by increasing interest rates in the first half of 2020, only to have to change position later in the year as investment pulls back again and the UK economy flirts with a slower growth trajectory.
In other words, UK interest rates are likely to remain the same at the end of 2020 as they were at the beginning of the year, with risks skewed to the downside. Looking at the forward rates 6 months projected it seems the rate market anticipates rates to trend lower at the short end of the curve.
For UK equities, increased visibility on the path to Brexit should be supportive. We expect investors to take advantage of the FTSE 100 index’s attractive valuation and high dividend yield once Brexit uncertainty dissipates. Although a stronger sterling has been a significant headwind for this exporter-weighted market for much of this year, we believe the negative correlation between the domestic currency and equities is likely to weaken in the short term.
As such, UK and global investors alike can benefit from a renewed interest in UK equities. The chance to participate in this increased popularity for the asset class may not last long though. The second half of 2020 may show how challenging it can be to negotiate the future trading relationship between the EU and the UK.
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