This is it. 31 January 2020 is Brexit day and marks the beginning of the end of the UK’s membership in the European Union.
But is this really it? Pretty much. The UK’s actual leaving date from the EU is 31st December 2020 as the UK will be in a so-called transition period between now and then. The UK government prefers to instead call it the “implementation period”.
What is the transition period about? This 11-month period gives time to determine the future relationship between the UK and the EU, especially on the trade and security front. From 31 January 2020 the UK stops being a member of the EU but will abide by EU rules and be a member of the single market and customs union until the end of the transition period.
Can the transition period be extended and how likely is it? Consistent with its promise to “get Brexit done”, the UK government has made it into law that they will not extend the transition period. However, given the short time left to agree a deal—which typically takes several years to agree and ratify--the UK government could request an extension and reverse this decision through new legislation. It remains unlikely at this stage, therefore the risk of the UK moving to World Trade Organisation terms on 1 January 2021 is real. This risk is somewhat priced into markets already, as can be seen with sterling trading at 1.30 against the US dollar and 1.18 against the euro.
What does this mean for the UK economy?
After three years of subdued business investment in the UK economy, CEOs should start deploying some capital. The Tory government should provide some confidence, even with the uncertainty surrounding the UK-EU trade relationship. This could be a reason why the Bank of England’s Monetary Policy Committee left interest rates unchanged at 0.75% yesterday. We think not cutting rates at this point makes sense. While on the one hand recent economic data has not been positive (core inflation low at 1.4%, weak monthly GDP figures, falling industrial production and weak retail sales in the fourth quarter), leading indicators are pointing to an improvement in the year ahead. The January Flash Purchasing Manager Indices (PMI) for manufacturing and more importantly services came in stronger than expected last week, which points to a stabilisation if not a rebound in the economy in the year ahead. The flash services PMI was the highest since September 2018. The Bank of England continues to wrestle with temporary Brexit-related factors and a labour market that remains tight. Although wage growth has fallen in recent months, at 3.2% year-on-year it is close to levels last seen before the global financial crisis. Unemployment is at a 45-year low of 3.8%.
How does this impact our view on asset prices? We believe that valuations for UK domestic companies remain attractive. In our Counterpoint 2020 Outlook, we highlighted a positive view on
sterling. With the parliamentary deadlock broken and expansionary fiscal policies expected from the Tory government, UK growth could positively surprise in the coming years. Improved economic growth relative to Europe and the US could pave the way for a stronger sterling. We maintain overweight exposure to sterling and UK domestic companies in portfolios.
If you have any questions please direct them to your usual Brown Shipley adviser.
The Investment Office
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