Next steps and economic fallout: Now that the United Kingdom is officially out of the EU, a new phase has opened up, during which UK officials will have to negotiate a trade deal with the EU to avoid a ‘Brexit cliff edge’ at the end of 2020. The available time span is short, but an agreement is possible on either a trade deal, another extension or some mixture of the two. The negotiations should be simplified now the UK is able to rely on a solid parliamentary majority, while on the EU side there can no longer be any hope that the UK will remain in the EU. Last year the possibility of keeping the UK in the EU could have acted as an incentive for Europeans not to offer an acceptable deal. In addition, despite his harsh tone, British PM Boris Johnson proved pragmatic in his negotiating strategy in 2019, and this pragmatism could again facilitate an agreement this year. However, there will be renewed moments of doubt related to that ‘Brexit cliff edge’ before a solution is found. Meanwhile, a US-UK trade deal is unlikely to be fully negotiated this year, while what happens next year will depend on the outcome of the US Presidential election. If Donald Trump gets re-elected a deal could be slightly more likely, while a Democratic President may feel less aligned with Johnson’s views. UK GDP growth is expected at 1.1% this year and 1.4% in 2021, from an estimated 1.3% in 2019. This is a slightly better outlook than in the Eurozone as the UK benefits from the announced fiscal stimulus, which could be a game changer for the British economy. Longer term, we expect Brexit to slightly impair the British growth trend through less vigorous labour market and productivity dynamics. Nonetheless, Britain’s potential growth will remain slightly stronger than that of the EU, due to demographic trends and also the fact that the UK remains an economy that is generally friendlier to competition and innovation. Investment implications: In fixed income, the 10-year Gilt is expensive, both in absolute terms and compared with other developed markets. We expect the UK yield curve to bear steepen as we foresee upside surprises from previously depressed survey data, low unemployment and the prospects for increased issuance due to higher fiscal spending. Playing curve movement could be a source of value to fixed income portfolio investors in a low-yield environment, particularly with many central banks now on hold. More generally, we expect some curve flattening in countries such as Japan, Europe and Australia, while we foresee curve steepening in markets such as Canada, where the central bank has not cut rates. On FX, the pound is likely to depreciate in 2020, hit by possible negative news flows on the ongoing negotiations and the dovish Bank of England (BoE) rhetoric. In equities, the UK market is cheap compared with its fundamentals and looks attractive in the long run. We see it as a buying opportunity, especially in relation to domestic-oriented stocks, for which the risk/return profile is most attractive.
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