There are just nine months left of the EU-U.K. negotiation period, which is a pretty short time, given the complexity and economic consequences of the Brexit. That is why the British domestic policy was highly dramatic during the past week, in particular Tuesday the 12th and Wednesday the 13th June. The government under Prime Minister Theresa Mays’s leadership simply tries to define Britain’s negotiating position. Perhaps the Prime Minister at least found a working foundation which is interesting for the financial market. At the same time, there is a risk that the U.K. economy will start to cool down, which also should have the government’s attention if they had time.
The two hectic days in the lower house (House of Common) in the British parliament once more was concerning the Brexit negotiations. It was needed because the upper house (House of Lords) had 14 amendments to a previous Brexit plan the House of Commons had approved. The drama was clear already Tuesday morning when Britain’s Justice Minister Phillip Lee stepped down with the message that he could not support the government’s Brexit plans.
The end of the negotiations, especially within the ruling Conservative Party, seems to be an agreement that the Brexit cannot be a so-called “no-deal exit”. In particular, the British lower house has taken even more power over the negotiations. The essence of the drama right now is that an agreement must be reached with the EU when Britain exits next year. The financial markets have feared that Britain simply leaves the EU without a real agreement about the future cooperation. This for example concerns trade agreements, but of course also under which conditions people can cross the borders and get work permissions.
If it comforts investors enough to let the investments flow faster towards U.K., that I am not convinced about. However, the U.K. decision is an element in my assessment of investment opportunities in the UK.
I now expect that the penalty Britain must put on the table to leave EU increased during the week as Theresa May’s negotiating position is weakened. The EU has mentioned around 100 billion euro in compensation. I estimate that the financial markets expect a cash payment of EUR 50 billion plus some other liabilities, but right now it remains open. Further, I could imagine that a number of trade agreements will be less favourable for Britain, but all these awaiting negotiations, I expect to be speeded up the coming 1½ month.
In relative silence, the British Prime Minister a couple of weeks ago announced that the 150-page working paper about the expected Brexit process won’t be packed in the suitcase for the EU summit on the 25th and 26th June, which otherwise was the plan. My best guess is that the Britons simply aren’t ready yet, which the recent political drama could indicate. The government in London mentioned that the working paper will be published later, though they will need to hurry up. Theresa May is forced to get the negotiations moving again before the whole European continent leaves for their summer vacation in August. My view is that the negotiations will exactly hit the thin summer market with headlines and generate extra movements in the British pound and in the U.K. financial markets.
Along with this possibly increased nervousness, several key figures show that Britain’s economy is experiencing increasing headwinds right now. As graphic one shows, the manufacturing output increased by 1.4 pct. in April compared to the previous year. Compared to the 2.9 pct. increase the month before, the drop is remarkable. However, the most worrying is that economists had expected an increase of 3.1 pct. in April. Graphic two shows the annual wage increase, including bonus payments, where one also can notice a small step backwards. All in all, Theresa May and her negotiating delegation do not travel to Brussels with strong cards on the hand, nor a strong economy to lean towards.
In addition, the inflation is still at the very low end of expectations. Therefore, there is probably no interest rate hike from the British Central Bank (the Bank of England) in sight.
My expectation is that the nervousness surrounding the entire British situation the next few months and the absent rate hikes could very well weaken the pound during the same period.
However, my main scenario remains that many negative expectations are already priced-in in the pound and all British assets, even in a part of the real estate market. Therefore, I continue to argue that interesting opportunities are arising for investors in U.K. and the timing moves closer.
I would like to emphasize that the second quarter has started with a range of macroeconomic data that has been on the soft side, including the numbers from the European continent. In general, the continent, and in particular the Eurozone, remains weak. As an example are the British wage increases, after inflation, more correctly moving down towards the German level.
And in fact, the political landscape within the Eurozone is completely blown apart at the moment. Should the United States become serious about import duties on European cars, then Germany really will feel the heat.
Despite the fact that EU has a significantly larger economy than Britain, the reality could well be that both the EU and Britain need all the export and trade that they can secure – so maybe the two parties find together much easier than the financial markets expect …
My view on the global asset allocation remains the same. I will continue to underweight Europe, but within Europe, Britain is still one of the few countries where I want to work towards an overweighting. It requires a belief that the Britons successfully can overcome the long-term Brexit challenge, but I also include the fact that I consider many negative factors concerning the Brexit already priced-in the market.