Jonathan Marriott, Chief Investment Officer
The United Kingdom (UK) and the European Union (EU) are reaching the final stages of negotiations on the post-Brexit relationship. The sticking points that have been evident all year on fishing, a level playing field and jurisdiction remain unresolved.
Fishing rights are particularly problematic and France have indicated that they will veto a deal if it is not satisfactory for them. The next EU summit is next week on the 10th/11th of December, which provides a final deadline for approval ahead of the 31st December transition period deadline. This would allow for a vote in European Parliament between Christmas and the New Year. The EU leaders' focus may be on agreeing a budget that is being blocked by Hungary and Poland, rather than Brexit. French President Charles de Gaulle said "non" to the UK joining the Common Market in 1967 and, as the UK exits the EU, it may be France again that says "non" to a new relationship.
From a market point of view, the value of the pound has been the most sensitive indicator of the Brexit outcome. In the last month, the pound has pushed towards the high of the year of around 1.35 dollars to the pound. In March, at the height of the pandemic, it was just 1.15. The appreciation of the pound since then could be read as an indication that the market thinks the ongoing negotiations will result in a deal. However, the latest move has been more to do with weakness in the dollar, rather than strength in the pound. Against the euro, the pound is only up about 2% from the March low. Looking back to before the 2016 Brexit referendum, the pound was at 1.47 against the dollar, so down 8%, and 1.35 against the euro, so down 18%. The options market is indicating that there are more negative bets on sterling than positive. So, as the foreign exchange market is still some way from pricing in a deal, we can still expect the pound to rally from here if there is a deal, and for it to fall on no deal.
The recent rise in the UK equity market has been driven by the vaccine news rather than Brexit. The pandemic has had a much bigger impact on the UK economy than Brexit. If there is no deal, the impact may be obscured by a post-pandemic recovery next year. Companies in the FTSE 100 have around 70% overseas earnings, so would stand to benefit from a fall in the pound. Thus there is a disconnect between stocks listed in London and the UK economy, with one not necessarily representative of the other. A no deal Brexit resulting in World Trade Organisation terms would see tariffs introduced on both sides of the English Channel. The concern, however, is less about the cost of the tariffs, but the administrative burden this would bring, and the potential chaos at borders as these are introduced.
As we enter another crunch week, financial markets have yet to fully price in an outcome, which, at this stage, is too unpredictable to call. In the end, we may have a partial or temporary deal with some matters left for further negotiations after the year-end. For equity and bond markets, the global economy and the speed of delivery of the vaccines may have a bigger impact.
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