INSIGHTS

With just 18 days until the UK is scheduled to leave the European Union (EU), a key summit this week looms as the last chance for a deal to be agreed upon. We have seen some positive developments on this front over the past several days, although the situation remains far from certain.

This coming Saturday could also be a key date, with this being the deadline for Boris Johnson to formally seek an extension beyond October 31, unless he manages to stitch together a deal (or receives approval for leaving with no deal). This will be the first time Parliament has had a Saturday sitting since the Falklands war in 1982.

The biggest risk is seen as a ‘no deal’ Brexit, where the UK crashes out of the EU without any agreement in place. Having a plan to tackle the mechanics of the transition is the preferred outcome, while the arrival of October 31 without anything in place could represent a fairly ugly situation for the UK.

Last year, the Bank of England ran a few scenarios to estimate what that might look like, and they weren’t pretty.

It suggested trade could fall 15 per cent, and depending on the level of disruption, the economy would contract between three and eight per cent.

This would push inflation and interest rates higher, while unemployment would rise materially. House prices would fall between 14 and 30 per cent, and the British pound would depreciate by 15 and 25 per cent.

The Bank of England even used us as a case study, analysing the trade disruption New Zealand experienced when we lost preferential access to the UK market in 1973.

The UK was our biggest trading partner at the time, taking almost a third of our exports and accounting for around eight per cent of our GDP. The transition was painful in the years immediately after, but we’ve more than moved on.

Today, the UK represents less than four per cent of our total exports, as our focus has shifted to the likes of China, Australia, the United States, Japan and Korea. All of those places are more accessible geographically, and many are growing a lot faster than the UK.

A few economists dismissed the Bank of England’s doomsday scenarios as outlandish. Maybe there’s a bit of truth in that, and to be fair more time has passed since this analysis so contingency plans will be in place for some. Still, a no deal Brexit isn’t exactly a desirable outcome regardless.

All of this uncertainty has weighed on the UK economy since the Brexit referendum took place in the middle of 2016. At the same time, Brexit uncertainty has ensured that the UK sharemarket and the pound remain unloved.

UK share prices have increased about seven per cent over the past three years, compared with the rest of the world, which has gained more than 30 per cent. Meanwhile, the pound is around 20 per cent below its 25-year average against the NZ dollar.

There have been a few positive signs during the last several days, and many will be hoping this continues. If Johnson, Ireland and the EU can agree on an eleventh hour deal of some sort, the clouds of uncertainty would start to clear.

The associated sigh of relief would improve the short-term outlook for the British economy, lifting asset prices and boosting the pound. It could also clear the way for the Bank of England to raise interest rates slightly, with these having been held artificially low on the back Brexit uncertainty.

Investors holding UK shares would also benefit, including the many New Zealanders who still have pension funds from their days in London.

Ironically, a deal wouldn’t be as positive you might think for the most widely followed sharemarket index in the UK, the FTSE 100.

Many of the largest UK companies are multinationals that derive a significant proportion of their earnings from outside the UK. A stronger pound is actually a negative for these export driven businesses, and positive news on the Brexit front may not do their share price any favours.

Investors who want to bet on a ‘Brexit bounce’ would be better served looking at smaller UK companies, as well as real estate assets. These are more exposed to the domestic economy, and therefore stand to benefit to a much greater degree.

The next week or two will be crucial, and there could well be a few twists and turns left in this story. At this point, it still feels like the only think the UK can bank on is with certainty, is more uncertainty.