Voters Say, ‘Bring on Brexit’

    Facebook Twitter LinkedIn Email

A Brexit resolution is in sight after more than three years of market uncertainty and high political theater following the June 2016 U.K. referendum to leave the European Union (EU).

U.K. Prime Minister (PM) Boris Johnson and the Conservative Party (Tories) gained a resounding majority in the general election held December 12. The Conservatives made significant gains in regions that had not supported their party since the Margaret Thatcher era. Johnson and his party are now reiterating their promise to deliver Brexit on or before January 31, 2020.

Results Remove Some Uncertainty

During the election campaign, Johnson pledged that, given a clear majority in Parliament, the Conservatives would be able to approve the withdrawal agreement he secured in October. They could subsequently affect an orderly Brexit by the end of January and begin negotiating new trade agreements with the EU, the U.S. and others. A majority of U.K. voters apparently wanted to put an end to the Brexit impasse and move on.

Markets appear to have priced in such a scenario in the weeks leading up to the general election. U.K. equities and the British pound rebounded. Optimism increased. During the long period of uncertainty surrounding Brexit’s resolution, investment into the U.K. and willingness of U.K. corporations to invest in new initiatives were essentially put on hold. Any light at the end of the tunnel suggests that these conditions may finally begin to be reversed.

We agree that the outlook for the U.K. has improved with the removal of some of this uncertainty. However, the nature of the ultimate trade agreement with the EU hangs in the balance and will so for at least another 12 months. The withdrawal agreement just gives the U.K. the right to leave the E.U. Officials still need to hammer out the terms of the ultimate trade relationship.

Opportunities and Challenges for Investors

We expect U.K. equities to benefit from an orderly Brexit. This period of uncertainty has been a major cloud hanging over the domestic economy and weighing on investor sentiment. Removal of some uncertainty should lead to increases in both investment and consumption. This could be especially beneficial to the consumer-facing economy, considering  unemployment remains low and wage growth has been strong.

Along with promises of a swift and orderly Brexit, the Tories pledged significant fiscal stimulus on the campaign trail. Johnson and his party outlined an aggressive spending plan focused on policing, health care and infrastructure. If implemented, the latter could be beneficial to construction and homebuilding companies. Further strengthening of the British pound, however, could weigh on earnings for U.K. exporters and internationally exposed companies, including pharmaceuticals, oil, industrials and consumer staples. Conversely, a stronger pound likely would boost earnings for domestically focused companies.

While heightened government spending may create opportunities for equity markets, it may also create  some challenges for bond investors. Johnson’s aggressive fiscal plan means that after nearly a decade of consolidation, public borrowing will increase. In the coming months, we believe this shift in policy will cause yields on longer-maturity U.K. bonds to rise, reflecting a higher sovereign risk premium. In addition, Moody’s recently assigned a negative outlook to U.K. government debt. We believe this may lead to a series of one-notch ratings downgrades from Moody’s in the next 12 to 18 months.

Rate Cuts in the Cards?

The Bank of England (BoE) has remained on hold since August 2018, keeping its key lending rate at 0.75%. The BoE’s future course remains unclear. On the one hand, lingering uncertainties associated with Brexit-related trade negotiations and the resulting pressures on growth may prompt the central bank to cut rates in 2020. In this case, we would expect one or two rate cuts during the first half of 2020, which would enable the BoE to anchor the short end of the yield curve. We believe the combination of central bank easing and increased government spending would re-steepen the U.K. yield curve.

On the other hand, swift trade resolutions and potentially higher gross domestic product (GDP) and growth expectations could negate the need for rate cuts. This scenario would support U.K. financial institutions that have been pricing in margin pressure and higher credit costs.

Deadline Pressures Loom

Johnson has said he won’t extend the Brexit transition period beyond 2020.  This gives the U.K. fewer than 12 months to forge a formal trade agreement with the EU—a very short timeframe by trade deal negotiations standards. Should negotiations for new trade agreements prove as contentious as Brexit negotiations were, a “no-deal Brexit” remains a possibility. However, the mandate voters gave the Conservatives puts Johnson in a better negotiating position.

Will officials be able to reach a comprehensive trade deal before the end of 2020, as the Conservative party suggests? We aren’t so sure. If they fail to reach a deal, U.K. trade with the EU reverts to a World Trade Organization-style agreement at the end of 2020. 

    Facebook Twitter LinkedIn Email

Insights From Our CIOs

Get additional insights in our latest Investment Outlook.

Discover More
  • Related Articles

Tax Proposals vs. Your Reality: What You Can Do Now

There’s a lot of news swirling about the potential for tax hikes. While we’re still far from any proposals becoming law, here are some things to consider if you’re concerned about what this could mean for your portfolio.

Russia-Ukraine Conflict: Three Implications for Developed Markets

Our Non-U.S. Growth portfolio team weighs in on how the Russia-Ukraine conflict may affect energy security, inflation and earnings.  

How Does the Fed Manage Inflation? It’s FAIT

The Fed has changed the way it thinks about inflation. Here’s what the new average inflation target policy means.

    The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

    American Century Investments is not responsible for and does not endorse any comments, content, advertising, products, advice, opinions, recommendations or other materials on or available directly or via hyperlinks to third party applications or websites. Logos or icons used are registered trademarks of their respective owners.