After years of Brexit uncertainty, the end of the transition period has finally arrived and the outlook for the UK is starting to improve, both for stocks and the pound. A post Brexit trade deal being struck with the EU and a solid rebound in the UK economy expected this year means that some sort of mini relief rally could be on the cards, although near term covid concerns can't be ignored.
Rebounding GDP Post Brexit for the UK
The UK economy was one of the hardest hit developed economies by COVID in Q2, which came at a time when the UK was already experiencing high levels of uncertainty over its future amid Brexit and post-Brexit trade talks with the EU.
The UK economy contracted by an unprecedented -19.8% in Q2, significantly worse than its European peers. Looking ahead, the Bank of England expects GDP to rebound 7.5% in 2021, which is more optimistic than the Office of Budget Responsibility which forecasts a 5.5% rebound; meanwhile the IMF expects 6.3% growth:
Limited gains for the British Pound (£)
The pound has seen a solid runup over the past few months, not just against the US Dollar which slipped to a 2 ½ year low towards the end of 2020, but also, albeit to a lesser degree, against the Euro. The rally in the Pound came amid increased expectations that a Brexit trade deal would be agreed.
A Brexit trade deal and the end of the transition period draws a line under years of Brexit uncertainty, making the UK more attractive to investors. However this is by no means the end of the story. The pound could struggle to gain much ground from its current levels around 1.35. Even with a deal in place, the UK still faces greater costs of doing business with the EU, the country’s largest trading partner, with no-tariff barriers potentially as high as 14% according to the Treasury.
So, whilst a small move higher could be on the cards, the upside could well be limited. Most investment banks project GBP/USD to trade in the 1.25-1.35 range by the middle of 2021:
GBP USD Currency Forecasts – British Pound £ Versus the US Dollar $
Source: Global Reach
However, should a more upbeat economic path be followed there is a good chance that the pound could spur higher.
FTSE Recovery in 2021
The FTSE has consistently underperformed every year since the 2016 referendum and the index has been underweight among managers’ consensus across the same period. Just as the market was starting to come to terms with Brexit, COVID struck the UK with its worst recession in 300 years.
However, with a Brexit trade deal agreed and the possible global COVID recovery in sight, investment banks are turning increasingly positive on the UK market. Morgan Stanley has identified the UK stock market as one of its key investment calls for 2021, along with Citi and Goldman Sachs to name a few. UBS even went so far as to say that the FTSE is their preferred market for 2021 with a target price of 6800 by June.
The end of the transition period and the skinny trade deal has at least removed some uncertainty surrounding the UK. This is expected to clear the way for more investment into the UK, potentially boosting the index in the coming months.
It is impossible to talk about the FTSE’s recent past and future performance without mentioning the global pandemic. With regard to COVID, the UK economy was more severely hit than some other countries, which was reflected on a steeper decline and a slower pickup for domestic stocks. The relative lack of technology stocks on the FTSE has meant that it missed out on the pandemic tech stock rally. However, it is better positioned to take advantage of the rotation into value stocks that goes hand in hand with the COVID vaccine recovery rally.
A possible global recovery in 2021 is expected to benefit industrial companies and sectors such as banking, house builders and energy which reflect the health of the economy.
British Pound (GBP), FTSE 100 Correlation
The only real problem that lies ahead for the FTSE could be the pound. With more than 70% of the FTSE’s revenues coming from overseas, the FTSE is a natural hedge against a decline in the Pound. However, its prospects could be hurt by a strengthening pound which hits the bottom line of many firms. In the 3 months immediately following the Brexit vote, the pound dropped 12% versus the US Dollar and the FTSE gained 10%:
This correlation has since broken down and the pound and the FTSE are enjoying the longest period of positive correlation since 2014. This means that should the trend continue, a stronger pound may not hold back the FTSE in 2021.
For further insight into what 2021 could have in store for the markets take a look at other titles in the series: