Brexit revisited

Brexit revisited

In the immediate aftermath of the UK referendum decision we produced an article detailing our early thoughts on the implications. We said we would provide updates as developments unfold.

There have been a lot of developments, including a new government, more monetary stimulus and undulating economic data. So now seems like a good time to wrap up our current views.

1) What might our new relationship with the EU look like?

Other than the new Prime Minister’s mantra “Brexit means Brexit”, we have heard so little in the way of detail about what Brexit really does mean that we might genuinely claim to know less now than we did immediately after the vote. We, for example, followed the conventional wisdom that the UK would choose between three basic choices: membership of the European Economic Area (EEA) like Norway; falling back upon the World Trade Organisations (WTO) rules; or a bespoke UK trade deal. Our European partners have been absolutely clear that if we want to be members of the Single Market then the EEA was the only way to achieve that (other than full membership). That option, however, would never fulfil the ambition of being able to limit immigration from within the EU so it would always have been controversial.

For that reason David Davis, the government minister charged with managing the UK’s departure from the EU (although the negotiations will be completed by the Prime Minister) was probably being realistic when he said that “a requirement of membership is giving up control of our borders.” That has been the consistent message received from other EU leaders. This led Mr Davis to conclude that membership of the European Single Market was “improbable”. The Prime Minister rebuffed his defeatist attitude.

What was in doubt before was which of the mutually exclusive priorities – membership of the Single Market or control of immigration – would take precedence. It seems that Mrs May has settled the matter. She has said the UK’s deal “must mean controls on the number of people who come to Britain from Europe but also a positive outcome for those who wish to trade goods and services”. While the “positive outcome for those who wish to trade” is vague, the imposition of controls is explicit. Continued unfettered access to the Single Market will come as a result of some masterful negotiation or, more likely, it will be lost. An immaculate exit is, to use Mr Davis’ term “improbable.”

2) The pound’s weakness

In the days following the Brexit vote, the pound fell sharply against virtually all of its trading partners. Under normal circumstances that should give it room to rise. However, sterling’s inherent weakness stems from the UK’s trade deficit. That means the UK must attract sufficient investment to offset the nation’s excessive spending, or see the pound fall to a level which will attract such investment. It is logical to believe that the referendum will have reduced the incentive to invest in the UK. If that is the case, however, the early evidence suggests the decline in the pound has been sufficient to offset this impact. Certainly there is anecdotal evidence of foreign buyers seeking opportunistic purchases in London property while the pound remains low.

3) Mortgage and interest rate cuts

The Bank of England took aggressive action at its August Monetary Policy Committee (MPC) meeting. The 0.25% interest rate cut and other stimulus that it announced will have added to the pressure on the pound. The Bank’s actions were despite tentative indications that the near-term performance of the economy might improve. It was also acknowledged that in the immediate term the likelihood was that inflation would rise rather than fall (ordinarily central banks would provide stimulus when they believe inflation will be low). We doubted whether the benefit of an interest rate cut would flow through to borrowers. Generally, the rate cut was passed on to those borrowers with tracker or standard variable-rate (SVR) mortgages. That said, a pronounced trend in recent years has been for households to move from floating-rate to fixed-rate mortgages. Floating-rate loans accounted for 42% of the mortgage market in 2010 but that share has now fallen to just 23%. Although the Bank left policy unchanged at its September meeting, it still took the opportunity to emphasise in its minutes that a majority of MPC members expected to cut interest rates again before the end of the year, to a level of just above 0%.

4) House price slowdown

As with the broader economy there was something of a shock factor in the immediate outlook for housing following the Brexit vote. Despite some rebound since, there remains evidence of a modest slowdown in house price growth. Generally robust leading indicators, such as the number of mortgages which have been approved over the last month, suggest that price growth is slowing. We can’t say how much of this slowdown – if any of it – results from the EU referendum. In many parts of Britain, house prices had reached historically high levels in relation to average earnings and as such seem to be held back by affordability alone. Lower mortgage rates will help to support prices a little, while in London – where property market valuations are the most stretched – the weakness of the pound has encouraged foreign buyers to snap up some “bargains”. Also, as we have pointed out previously, the market is undersupplied to the tune of about 75,000 new homes per year, which will help to support prices.

House prices will be vulnerable if more tangible negative consequences of Brexit start to come through. If companies are reluctant to invest or hire because their trading arrangements with the EU are unclear, then slower employment and wage growth will weigh on the property market.

5) Stock-market benefits

The stock market has rebounded strongly from its immediate drop following the referendum. With the process of leaving the EU yet to start, and confidence having broadly held up, the only meaningful impact on UK shares has been lower interest rates and a weaker exchange rate. That combination of factors makes equities more valuable. Many UK shares derive some part of their business revenues from overseas and those revenues are now worth more in pounds. In addition, the value of shares has some relationship, vague and abstract as it might seem, to the returns available from other forms of savings. As the interest which investors can earn on cash savings falls, the more willing they will be to take risk in the equity market instead.
We still don’t know much about the future in a post-Brexit environment, but we have seen some very significant expressions of preference from policymakers. The government appears to be willing to sacrifice membership of the European Single Market, in order to enforce a more prescriptive immigration policy. It seems likely that this would have negative implications for the UK economy, most likely through reduced investment.
Meanwhile the Bank of England seems willing to ignore the expected inflation which looks likely to show itself in consumer price data from November onwards. Instead it has expressed a preference for lower interest rates in order to lessen the impact of the UK’s disrupted trading arrangements with its economic partners.
While the whims of policymakers are prone to change, for now these circumstances favour a portfolio containing equity investments. There are, however, likely to be further twists and turns in the road out of Europe.


Guy Foster, Head of Research
Guy leads Brewin Dolphin’s Research team ensuring that a rigorous and exhaustive investment process is employed. He also provides recommendations on tactical investment strategy to Brewin Dolphin’s investment managers and strategic recommendations to the group’s Asset Allocation Committee. Before joining Brewin Dolphin in 2006, Guy was an Investment Director at Hill Martin (Asset Management). Guy has a Masters in Finance from London Business School. He is also a CFA charterholder, holds the CISI Diploma, and is a member of the Society of Business Economists. Guy frequently discusses financial issues with the written and televised media as well as presenting to the staff and clients of Brewin Dolphin.

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