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11/10/2017

How Brexit Has Affected Investments

With the triggering of Article 50, negotiations on the UK’s exit from the European Union can begin. But what do Brexit and its possible consequences mean for investors?

Leaving the European Union (EU) could be the most significant change to the UK economy in a generation. Then again, the impact might be so small, we may not even notice.

Clarity around these issues is unlikely to prevail for some years yet. So, from an investor’s perspective, listening to market noise and rushing to judgement either way is not a good idea. Successful investing is not the same thing as predicting outcomes. Instead, investors would do well to take a step back and assess what is really going on.

We know that the UK economy remained stronger than many expected in the wake of last June’s referendum, growing by 2% overall in 2016. Despite this, forecasts for future growth are downbeat. The Organisation for Economic Co-operation and Development (OECD) has projected that UK growth will slow to just 1% in 2018 in stark contrast to its forecast for global expansion of 3.6%, up from 3% last year.

Given the UK economy has defied expectations of a post-referendum slowdown, it might be worth considering interest rates. The view that the Bank of England will keep base interest rates at their record low is predicated on a slowdown in economic growth. In my view, a higher pay rise for UK workers could be an early precursor of an interest rate rise.

With unemployment close to 40-year lows and consumer price inflation already having edged up to 2.3% in February, and expected to rise further this year, the Bank could easily justify raising base interest rates if wage growth is also on the up.

This would be a jolt to many investors. As ever, where market beliefs become detached from facts, it creates opportunities for those investors who take a long-term view. We need to expect that attention on Brexit will wax and wane in the coming years and, as investors, be prepared to respond as it does rather than getting caught up in the noise.

Financial services and the City

Financial services have more to lose immediately after a European Union exit than most other sectors of the economy. Even in the best case, in which passporting rights were preserved, the United Kingdom would still lose influence over the single market’s rules. The City would probably be hurt in the short term, but it would not spell disaster. The City’s competitive advantage is founded on more than just unfettered access to the single market. A European Union exit would enable the United Kingdom to broker trade deals with emerging markets that could pay dividends for the financial services sector in the long run.

Trade and manufacturing

Official trade statistics show that the European Union is the destination for about half of all British goods exports. The trading links are bigger if we include the countries that the United Kingdom trades freely with because they have a free trade agreement with the European Union. These agreements mean that 63% of Britain’s goods exports are linked to European Union membership.

It is highly probable that a favourable trade agreement would be reached after Brexit as there are advantages for both sides in continuing a close commercial arrangement. But the worst-case scenario, in which Britain faces tariffs under ‘most-favoured nation’ rules, is certainly no disaster. Exporters would face some additional costs, such as complying with the European Union’s rules of origin, if they were outside the single market. However, these factors would be an inconvenience rather than a major barrier to trade. In addition, fears that exporters would be left high and dry the day after the Brexit vote are unfounded. Under the Lisbon Treaty, a country leaving the European Union has 2 years in which to negotiate a withdrawal agreement.

In addition, falling tariffs, the decline in manufacturing and Europe’s diminishing importance in the global economy mean we doubt that even the absence of a trade deal with the European Union would hurt the United Kingdom’s overall exports materially. The benefits of being in the European Union are smaller than they were a few decades ago, when a Brexit would have been a far bigger deal. However, the effects will vary across sectors. Brexit would give Britain a crucial opportunity by allowing it to broker its own trade deals with non-European Union countries; indeed Britain could even have a unilateral free trade policy. Non-European Union countries may find negotiating with Britain easier and quicker than dealing with the European Union’s bureaucratic machine, as Switzerland has shown.

The production sectors in the economy face a more uncertain outcome than services. The range of potential outcomes is more variable as production sectors are more dependent on whether or not the United Kingdom agrees a trading agreement with the European Union and the nature of any such agreement. The possibility of tariffs on goods exports to the European Union gives greater downside potential, while the opportunity to open up trade with other countries or to increase the sector’s competitiveness through greater competition or cheaper inputs gives it more upside potential.

Contrary to the claims of many authors and commentators, it is probable that the impacts of Brexit on trade would be relatively small. Moreover, it is certainly possible that leaving the European Union would leave the external sector better off in the long run, if Britain could use its new found freedom to negotiate its own trading arrangements to good effect.

Foreign Investment

Concerns about a drying up of foreign direct investment if Britain votes to leave the European Union are somewhat overblown. Access to the single market is not the only reason that firms invest in Britain. Other advantages to investing here should ensure that foreign firms continue to want a foothold in the country. It is likely Britain would remain a haven for foreign direct investment flows even if it was outside of the European Union. Of course, we could see a period of weak foreign direct investment inflows as the United Kingdom’s new relationship is renegotiated. However, if Britain is able to obtain favourable terms, then foreign direct investment would probably recoup this lost ground.

According to a survey by M&G Investments, most of their investors take an optimistic view of ‘Brexit’, with only 13% saying it has changed their attitude to investing, and 34% waiting to see how things turn out.

87% of the M&G investors said they’d made no changes to their investment portfolios since the referendum, while 10% decided to add to their investments or switch between funds. Global equity funds have been the most popular choice for investors adding to or switching between funds, with UK equity funds a close runner up.

What their survey shows is that investors are taking a sensible long-term approach to their investments. Prices and expectations are all over the place following the Brexit vote and there is still uncertainty over its implications

Although the impact of Brexit on the British economy is uncertain, it is doubtful that Britain’s long-term economic outlook hinges on it. Things have changed a lot since 1973, when joining the European Economic Community was a big deal for the United Kingdom. There are arguably much more important issues now, such as whether productivity will recover. The shortfall in British productivity relative to its pre-crisis trend is still over 10%, so regaining that lost ground would offset even the most negative of estimates of Brexit on the economy.

By Nishad MUKHERJI

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