It is now over a year since the UK went to the polls, and voted to leave the European Union. We see regular publicity about the impact of the Brexit negotiations and various government policy decisions on the GBP and the FTSE 100, but what about private investors?
Are you feeling the Brexit impact?
What should you be doing about it?
Since the vote, the Brexit impact on financial markets have been taking somewhat of a Jekyll and Hyde approach: the FTSE 100 has rallied by 17%, while the pound has fallen by 14.5%. A great deal has changed in the way we think about investment, even as progress on the actual shape of Brexit has been minimal.
“Most independent economists were forecasting a downturn in the economy immediately after the vote,” says Azad Zangana, senior European economist with Schroders, the UK fund manager. “The Bank of England cut interest rates to a new record low, restarted quantitative easing and added extra emergency liquidity measures. However, the economy accelerated immediately after the referendum. Households ignored the depreciation of the pound and the growth in consumption accelerated.”
This wave of optimism took the UK economy to the top of the G7 growth table by the end of 2016. Yet this also represented an unsustainable spurt of growth. A depreciating pound has driven up inflation and has also squeezed disposable income. Savings rates are at record lows, and UK households have had no choice but to cut back on their spending.
The Bank of England is now taking a slightly more hawkish view: it is thinking about withdrawing some of its emergency stimulus measures, and while rates are unchanged for the time being, they will almost certainly be raised in the near term.
The Brexit impact on UK Bond markets
After the vote, the UK 10 year gilt market was hammered. From nearly 1.4%, it fell to under 1%. When the Bank of England said it would cut rates in August 2016, the yield was down to 0.52% before finally recovering as ‘Trumpflation’ took hold in the autumn. However, it looks like we are not out of the woods yet – if you are a bond investor, you have a lot to worry about.
“With that trade fading, and consumers being squeezed by inflation, bond yields have fallen again to 1%,” explains Alix Stewart, a fixed income fund manager at Schroders. “Corporate bond spreads – the difference in yields between corporate bonds and government bonds – have tightened. The BoE’s bond purchase programme brought about a rush to borrow at low rates by companies. However, in a world of abundant central bank liquidity, UK corporate bond yields have not tightened much more than they have in other global markets.”
While the Bank of England may not have raised interest rates yet, it has stopped buying gilts and corporate bonds, and this is having an impact on the market.
So where does the Brexit impact leave us?
Sailing in decidedly choppy waters, is where it leaves us. The good news – the risk of a second Scottish referendum is much lower following the recent election, which saw the Scottish nationalists receive some significant poll reverses. The actual shape of a Brexit agreement is also very vague. This has not yet translated into capital flight from the UK, however.
From our perspective – and we speak to a lot of professionals in the City of London, and further afield, confidence in the UK as somewhere to invest and do business remains high. Worries exist, of course. Will Brexit talks be finalised before the Article 50 deadline? Will the government be able to get Parliament to vote on a treaty without the existence of an absolute majority? Will it be able to implement more reflationary policies, and keep taxes low, which many foreign investors hope?
UK investors are facing a great deal of uncertainty one year on from the Brexit vote. Thus far, it has not been as bad as many have feared, unless you were locked into a long sterling position, of course. But there are still plenty of things that could go wrong in the economy, the equity markets, and most particularly, with inflation. Our fear is that inflation is the elephant in the room, which is why the Bank of England is quietly edging its way towards an possible interest rate hike.
It may come sooner than many pundits in the City believe.