100 days of Brexit: negative impacts for the UK on the rise
At the beginning of January, the time had finally come – the transition period of the Brexit Agreement ended and the United Kingdom left the EU for good. This not only made the UK a third country and fundamentally altered the relationship between it and the EU, it also changed the UK’s access to the EU’s single market. Now, 100 days after Brexit, we are taking stock of the situation – and it has become clear that Brexit is already causing far-reaching economic changes, and there seems to be no end in sight.
According to the European Commission’s latest calculations, Brexit will prove costly for the UK, with the damage to the British economy by the end of 2022 estimated at more than GBP 40 billion. With a gross domestic product (GDP) of around GBP 2 trillion, this corresponds to about 2.25 percent. By way of comparison, an average loss of around 0.5% is expected for the EU states. The more difficult trading conditions, in particular, are weighing on the economy. Although the UK and the EU were able to agree on a free trade agreement, which means that trade will remain duty-free, at the same time, the bureaucratic burden is increasing. For example, British companies must prove that goods exported to the EU were predominately produced in their own country. In a globalised economy with, at times, complex supply chains, this is not an easy task.
On top of this, there are also health and safety checks, VAT on imports, as well as other time-consuming obstacles that restrict trade. Many companies, particularly small and medium-sized ones, do not feel able to cope with the bureaucratic challenges and have temporarily stopped exporting altogether. According to the New York Times, the volume of exports that crossed the channel in January plummeted by more than two-thirds compared with the previous year. Producers of fish, meat and dairy products have been particularly affected – in some cases there are reports of tonnes of rotting food that did not make it through the bureaucratic minefield to the ports in France and the Netherlands.
London continues to lose ground as a financial centre
Even the British financial industry, which for a long time was the most important and largest hub for securities trading in Europe, is feeling the consequences of Brexit. Virtually overnight, equity trading moved to continental Europe, in particular to Amsterdam and Paris, while derivative trading has largely migrated to New York. The settlement giant, Euroclear, recently completed the transfer of some 50 Irish securities with an equivalent value of around EUR 100 billion to Brussels - these were previously settled in London. Until now, Ireland has relied on the UK-based Euroclear branch “Crest” to settle securities transactions.
The changes brought about by Brexit are far-reaching and they are still in their infancy. The rules around future trade relations are still being negotiated and the initial points of contention regarding the special provisions for Northern Ireland show that the Brexit chapter is far from over. In order to avoid border controls between Northern Ireland and the Republic of Ireland, the EU Withdrawal Agreement provides that the rules of the EU’s single market will continue to apply to Northern Ireland. To this end, a trade border between Northern Ireland and the rest of the UK was to be introduced at the end of the transition period, but at the latest from the beginning of April. Now, however, the British government has unilaterally extended this grace period, which the EU considers to be in violation of the Agreement. As the British government has not yet retracted its announcement, the EU is now taking the matter to the European Count of Justice. If the Court rules in favour of the EU, financial sanctions could be imposed. As a result, the mood between London and Brussels is becoming increasingly tense.
British pound far from pre-Brexit levels despite recovery
Despite the initial difficulties, the British pound has gained markedly against the euro since the UK left the EU. While the British currency was sitting at around 1.10 in December, today one pound is already worth 1.16 euro. This is certainly due in part to the much more successful vaccination campaign in the UK. Not only has the over-70s risk group been vaccinated, but one in four British adults have also received their vaccination. Secondly, the currency is being supported by the fact that the uncertainty surrounding Brexit has all but disappeared. Now, according to the widespread opinion of many Brexit supporters, London is once again in control of its own foreign policy and economic destiny, and this is not only reflected in the success of the vaccination campaign, but for the future also in the reinvigorated trade relations outside Europe, for example with China and the US. However, it is also true that the pound’s recovery started from an extremely low level in historical terms and is still a long way from the pre-Brexit levels of over 1.40 euro. Over the short term, the strength of the pound could certainly gain further momentum, but in the long term, it remains to be seen whether London can derive a sustainable economic advantage from its ostensibly regained sovereignty and vaccination edge.
In the short term, selling pressure for Gilts could continue
Since the start of this year, British 10-year sovereign bonds (or Gilts) have experienced their worst quarter for years, with vaccination progress, a brightening economic outlook, and vanishing Brexit uncertainty putting upward pressure on yields. Investors have previously made investments that assume the Bank of England might need to cut interest rates to below zero to help boost the economy, but as confidence in the economic outlook has grown, the narrative has shifted, triggering selling pressure in UK bonds. This has led to a widening of the spread between British Gilts and Bunds, as the outlook in Germany and the EU in general is much more subdued and the ECB has not only continued their bond purchases but even announced to increase them to keep yields low. We expect the selling trend in UK debt to continue over the short term and to underperform EU sovereign bonds. In the medium term, this trend could level out, namely when Europe catches up with the vaccination backlog and the ECB starts following the strategy of the FED and BoE by letting yields run a little higher.
In conclusion, we believe the Pound Sterling will continue to appreciate against the Euro in the short-term, given its still historically low levels and the better economic outlook. Likewise, selling pressure for Gilts could continue with less demand for UK safe haven assets and foreign investors reconsidering their investments in Gilts. Medium-term, however, we believe that the EU will catch up and Brexit-related issues will once again come to fore.
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