27 November 2018
During the past two years, not knowing what an exit from the European Union will look like has been the most significant challenge for UK companies and those wishing to do business in Britain. Uncertainty has stymied planning and held back investment.
A U-turn on Brexit in its entirety is still the best way forward for British businesses. However, while we live in hope, Prime Minister Theresa May’s proposed deal provides some certainty and should rein-in market volatility in the short term. It advocates that laws governing financial markets and business should remain equivalent between the UK and the EU until December 2020. During this time there should be no expectation of significant disruption to supply chains. The current movement of city jobs to European financial centres may also slow until the longer-term future relationship becomes clear.
With business once again encouraged to invest, the economy and the City of London stand to benefit, but this transition is by no means a done deal.
The odds of this compromise passing parliament on 12 December are slim. If the proposed Brexit deal fails to make it out of the chamber, no one can guess what will happen next. A second referendum could be on the cards, albeit Theresa May will not call it and Jeremy Corbyn does not seem too enamoured with the idea either. A dispassionate analysis of this week’s state of affairs suggests a high probability of the UK exiting the EU with no deal.
To the unpractised eye, major UK stocks traded in London have until now defied all negative economic predications made ahead of the 2016 vote. The reality is this performance has been propped-up by the over 20% fall in the value of sterling against the US dollar since the referendum. As at least 40 FTSE 100 firms pay dividends in dollars, the markets have been supported by domestic investors looking to profit from this favourable exchange rate.
By November 2016, the largest 50 FTSE 350 stocks, which make 70% of their revenue from outside of the UK, gained £211 billion (19%). During the same period, the largest 50 FTSE 350 stocks, which derive at least 70% of their income from within the UK, lost more than £40 billion (10%).
According to my research in collaboration with my colleagues at the University of Edinburgh Business School, the disparity in valuation continues. The only plausible explanation is lack of investor confidence in UK-focused stocks. Unless the proposed deal is passed or the whole process is reversed, this confidence will not be restored. And without it, the short-term future of the UK economy is bleak.
Outside of the EU, a no deal Britain will be at the mercy of new trading partners acutely aware of its desperation. Forced to offer extra accommodations to countries such as New Zealand and Australia, the country will find itself at the losing end of tariff-rate quotas (TRQs) and World Trade Organisation (WTO) negotiations. Critical sectors such as agriculture will undoubtedly suffer. WTO countries are already raising objections to the EU/UK plans of splitting existing TRQs – something that would otherwise be uncontroversial.
The UK economy is resilient and it will recover in the long term, even if Brexit is as disorderly as it now seems. However, in the medium term a no deal outcome will leave Britain incredibly vulnerable to external shocks, such as another global financial crisis, for at least a generation. Who knows how long it will take for the UK to find its way back to the country it once was.
Dr Gbenga Ibikunle is Senior Lecturer in Financial Markets at the University of Edinburgh Business School