11th July 2019
Is the Outlook for the UK, Okay?
by Chris Bailey, European Strategist, Raymond James Investment Services
The great Indian novelist Ruskin Bond may have complained about spending four years in the United Kingdom in his younger days but – in today’s world – a mere three plus years since the June 2016 Brexit referendum result, has caused material angst for politicians, entrepreneurs, the average family and investment strategists alike.
I do not need to give a blow-by-blow account of the failure of the government to find an acceptable Brexit deal for both the European Union and the UK Parliament, but it is not too controversial to say that another year of paralysis is in nobody’s natural interest. After all, despite some positive news about both wage and employment levels, the UK’s anticipated 2019 economic growth rate – as currently estimated by supranational organisations such as the IMF and the OECD – is expected to be below the broader European Union average and specifically only above troubled economic actors such as Italy.
As it happens, the confused current political backdrop in Italy is replicated in the UK, judging by the unusual nature of recent local council and European Parliamentary election results. Still, with the leadership battle in the Conservative Party – with an aim of not only establishing their new leader but also the next Prime Minister too – close to a finale, there is naturally some hope of new impetus to bringing clarity to the Brexit debate.
I have talked on these pages before about my anticipated ‘soft Brexit’ scenario. When I look at the Parliamentary maths, such a scenario of respecting the direction of the June 2016 vote whilst acknowledging the need to maintain a closer-than-average trade relationship to support integrated supply chains, appears to be the only logical option. However, logic and a range of strongly held views can be strange bedfellows and reluctantly I have to concede that other options, including a second confirmation referendum and even ‘no-deal’, still linger and could even spill over into an autumn election or even a constitutional crisis around the debate about a potential suspension of Parliament.
The Bank of England have not been shy in highlighting the impact of such uncertainties on economic growth and investment levels and perhaps naturally – despite an inflation rate which remains stubbornly at or even above the targeted 2% level – anticipation of an interest rate cut during the second half of 2019 have risen. Certainly, the recent fall of the ten year gilt yield below the current bank base rate of 0.75% – something which statistically has not occurred for over a decade – is reflective of the market signalling this possibility. However such a move, as well as any fiscal boost by the new Prime Minister, in accordance with some of the pledges being made on the leadership campaign trail, is just a stimulus sticking plaster over a lack of defined Brexit deal wound. It is certainly better that the UK has some room for new stimulus but by no means should this be seen as a cure.
We have all seen how a combination of uncertainty and slower economic performance has impacted the value of the Pound over the last three years. On conventional criteria the UK currency looks cheap against its international peers… but even a neophyte foreign exchange analyst knows that a nation’s currency value is largely a live financial market referendum on that country’s credibility and confidence levels. In short, the only way the Pound is going to start to materially scrabble back against the other major currencies of the world is via some form of Brexit plan clarity.
Naturally the UK equity investor is a little less concerned by all these developments given the weighting of non-UK earnings across both the large and mid cap indices, even before mention is made of the significant dividend yield pick-up in many UK listed stocks versus the aforementioned significantly compressed 10 year gilt yield. Certainly it has been noteworthy in the last month or two that the UK has crept off the bottom of recent fund manager allocation surveys as global investors in aggregate have shifted from being very underweight UK stocks to being more modestly so. However, within this, there remains significant reallocation scope to more domestically focused sectors such as the financials, retail and construction in the event of a Brexit deal.
Clearly the outlook for the UK economy – if not UK equity markets – is shorter-term wrapped up with the political enigma that is Brexit and – despite some scope for both interest rate and fiscal stimulus – the real key for the balance of the year is to provide some clarity on this front. And if adept political leadership is likely be required at the top of the UK policymaking tree to achieve this, then such achievements will just bring us to an end of an economic beginning. The 2020s is likely to be a challenging and complex (but not unopportunistic) decade for all global economies. The time to stop Brexit navel gazing and forging any plan of action is most certainly nigh if we all want at least the potential hope of ‘better prospects’.
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