What would a no deal Brexit mean for markets
FOREX.com December 11, 2020 5:00 PM
The UK and the EU are on course for a no-deal Brexit that could rattle financial markets. We look at what it means for the pound, the FTSE 100, and stocks.
- What does a no-deal Brexit mean?
- How would a no-deal Brexit impact GBP?
- How would a no-deal Brexit impact the FTSE 100?
- How would a no-deal Brexit impact stocks?
What does a no-deal Brexit mean?
Brexit has brought nothing but uncertainty for the last four-and-a-half years, but we do know that, whatever the outcome, the relationship between the UK and the EU will be different at the start of 2021. Trade is currently flowing across the Channel as normal whilst the UK remains part of the EU’s single market and customs union during the transition period, but that will come to an end on December 31.
There will be changes that businesses will have to adapt to even if a new trade deal is agreed, but both sides have strived to minimise disruption and based negotiations on their existing relationship rather than trying to draw-up an agreement from scratch.
The changes are much more dramatic under a no-deal scenario. With no agreement in place, trade between the UK and the EU will have to fall back on World Trade Organisation (WTO) rules. This means new tariffs and barriers to trade, such as border checks, will be introduced on January 1 that didn’t exist the day before.
The WTO sets the terms of international trade between countries that have not signed a trade deal. In a nutshell, it provides a one-size-fits-all system that isn’t ideal for any country. Therefore, countries endeavour to strike deals with their main trading partners so they can cater terms to their specific economies and create mutual benefits that cannot be achieved on WTO terms.
No-deal would cause significant disruption for both sides, especially the UK. The EU is the UK’s single largest trading partner with 54% of everything imported into the UK coming from the EU, whilst 43% of UK exports head to the bloc, demonstrating the UK’s reliance on its closest neighbour.
Plus, the UK’s trade with other countries will also be affected. Trade with non-EU countries is currently governed by trade deals that have been signed with the EU and the UK will lose access to them at the end of the year. The UK has managed to get the likes of Canada, Norway, Switzerland and Singapore to sign new trade deals on the same basis as they trade with the EU, and it has struck new deals with countries like Japan that don’t have a deal with the EU. Still, the vast majority of the UK’s international trade will not be covered by any trade deals at the start of next year if an agreement can’t be reached with the EU.
Notably, a no-deal Brexit at the end of the year does not prevent the UK and the EU continuing discussions about a trade deal, but it could mean trade would fall back on WTO terms in the meantime.
How would a no-deal Brexit impact GBP?
The pound has taken a battering this week, with GBP/USD having shed 1.9% while EUR/GBP has strengthened by 1.9%. Sterling’s weakness has demonstrated markets believed a deal would materialise and that they had not fully priced-in the possibility of a no-deal Brexit until this week.
It is likely that the pound would recover its recent losses and more if a last-minute deal is announced, but confirmation that we are headed for a no-deal Brexit in three weeks’ time is likely to drive sterling down even further against the euro and the dollar.
A weaker pound would have widespread effects for the UK – some good, some bad. On the downside, new tariffs and barriers under a no-deal Brexit would push up the price of imported goods and a fall in the pound would only exacerbate that – driving up inflation and the cost of living at a time when the economy will suffer from the cliff-edge divorce. On the other hand, it makes UK goods cheaper for overseas buyers and boosts exports, while also making UK assets more attractive to overseas investors.
How would a no-deal Brexit impact the FTSE 100?
The FTSE 100 has underperformed compared to other major indices this year and the lack of clarity spawning from Brexit is the main cause.
Although the world is only starting to stage what will be a slow and steady recovery from the coronavirus-induced crisis that has caused economic turmoil this year, US markets have recently touched new all-time highs. European indices have also bounced back well since the sell-off in March, with the DAX trading just 5% below pre-pandemic levels. Meanwhile, the FTSE 100 is still down 12%.
A last-minute deal would provide the clarity needed for the FTSE 100 to stage a quicker recovery, but the impact of a no-deal Brexit is more complicated. On one hand, it is hard to imagine how the index – used as a barometer for how the country’s biggest businesses are performing – will benefit from the UK’s international trade being overhauled overnight.
On the other, many companies in the FTSE 100 are large and geographically diverse enough to weather any major disruption. Plus, softer sterling tends to provide a boost to the blue-chip index because its internationally-focused constituents see their overseas earnings boosted when they are converted into weaker sterling. Just 29% of the FTSE 100’s revenue is generated in sterling, according to Schroders. Still, it is not certain that a fall in sterling will be enough to offset concerns about how a no-deal Brexit will impact businesses.
The FTSE 250 is expected to underperform the FTSE 100 in the event of a no-deal. This is because the performance of more domestically-focused stocks is more closely-tied to the health of the UK economy, which is expected to suffer in the event of no-deal. Plus, a weaker pound would hurt sales and margins. This is also true for some blue-chip stocks. For example, Lloyds is seen as highly exposed to a no-deal because it exclusively concentrates on the UK market compared to international peers like HSBC and Standard Chartered that are more geared towards Asia.
How would a no-deal impact stocks?
There will also be opportunities trading individual stocks. The key is to identify which stocks will be most affected by a no-deal Brexit as well as those that can prove more resilient. The impact of a no-deal would vary wildly for individual companies and industries. The key considerations when analysing the effects on different companies are; where does the company source and make its products, where does it sell them, and what currency does it generate revenue in.
One example of an industry that will undoubtedly suffer disruption from a no-deal is the UK supermarket stocks. They will, regardless of what happens, have to continue to import produce over the Channel and a no-deal Brexit would only push up prices and upend the industry’s ‘Just-in-Time’ supply chain.
Similarly, foreign carmakers would be among the biggest losers. Currently, newly-finished cars flow freely between the UK-EU tariff-free, but a no-deal Brexit would introduce a 10% tariff and cause delays at the border for the swathe of car parts that cross the border each day. The vast majority of cars made in the UK, made by the likes of Nissan and Toyota, are exported to the EU, while the UK is also a major destination for cars made in the EU.
At the other end of the scale, there are stocks that could outperform the wider market under a no-deal. Defensive plays would become more popular as investors seek safe stocks that provide reliable income such as water stocks Pennon and United Utilities. Truly global companies that count the UK as a small market, such as Diageo or British American Tobacco, are likely to be less impacted by a no-deal due to their size and geographical diversification. The same is true for the big mining companies that have the added benefit of reporting in dollars, shielding them from any adverse or volatile movements in GBP.
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