Monthly: Hard Brexit and other disruptive scenarios
- FX: A no-deal Brexit currency fallout would likely be worse than the Brexit referendum
- Rates: If a hard Brexit takes place, UK Gilt yields would be sharply lower across all tenors
- Equities: Despite smaller exposure of Singaporean firms to the UK, defensive strategy is better
- Credit: Asian credits, in general, have limited exposure to the UK
The UK has been the second largest economy in the European Union-28 (after Germany), so its pipeline departure has major ramifications in any case. But the un-ending uncertainty around the departure is particularly damaging. Moreover, the soon approaching end to the two-year deadline to depart under Article 50 comes at an inopportune time, as cyclical forces slow growth, while the political environment turns more challenging. Consumer sentiment gauges have been bearing the brunt of the compounding uncertainty.
Source: CEIC, GfK Group, DBS Group Research
The EU and the UK are inter-twined on the FDI and trade front. Half of the UK’s goods trade is with the EU. By contrast, less than a fifth of EU28’s trade (intra-EU) is with the UK. On investments, the UK was amongst the top few countries (besides Netherlands and Luxembourg) in the bloc, to attract the most FDI. In turn, the EU is the amongst the largest sources of UK inward FDI positions when using the immediate parent country, accounting for 45% of total inward positions, according to the Office of National Statistics. However, when linking to the ultimate controlling parent country, the EU and the North America recorded a similar quantum.
There is a key difference between the post-referendum period in mid-2016 and a potential no-deal outcome, at present. In the past two and a half years, there has been no material change in the UK’s trading relationship with the EU. Yet there has been tangible, even if modest, impact on the UK economy, through slower growth (1.8% in 2016 to 1.4% in 1Q-3Q18), weaker net exports and inflation pullback, after the initial rise (due to a weaker GBP). The stronger growth backdrop in the Eurozone, US and globally, however, helped prevent a deeper economic correction in the UK.
This strength runs the risk of running out of steam if ongoing negotiations lead the UK down the road of a no-deal Brexit. Prime Minister Theresa May has opted to keep the ‘no-deal’ outcome as a possibility on the table, if discussions with the parliament breaks down before the end-March deadline. Such an outcome would imply that the advantageous Britain’s access to Europe’s single market (with low/zero tariffs and lower technical, legal and bureaucratic hurdles to trade/conduct business) will cease to exist. Imposition of trade barriers or increase in tariffs would hurt European and UK exporters. Given the geographical proximity and significant share of bilateral trade between the EU and UK, the push to seek emergency/bilateral commercial agreements will be high, but UK’s higher reliance on trade with the EU suggest the terms might not be in its favour.
More importantly, UK growth slowdown risks are rising, at a time when activity in the broader EU (particularly Germany, France etc.) is also moderating. The political environment is also more challenging, as Eurosceptic and right-wing parties have increased their foothold in the core economies. The EU governments took a hard-line approach towards the UK in wake of the referendum. The tougher political climate in the past two years, however, will push them to seek a middle road – wary of setting a precedent for economies seeking to exit the EU but yield some ground to the UK to minimise any negative fallout on the EU growth/investments. In recent remarks, the Bank of England Governor had highlighted that the authorities have built in the risk of a ‘hard Brexit’ in their assessment. Back in November 2018, a BOE study had estimated that UK growth might decline by 8%, unemployment might rise to 9% and interest rates might need to be raised.
With businesses not adequately prepared for trade disruptions, and markets yet to discount risks of a no-deal Brexit, the risks are skewed to the downside at this juncture, in our view.
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