How bad could Brexit be on financial markets?

4th February 2019

The Author: David Cooper
Financial strategist, investment adviser and Sales Director for United Advisers

With the EU and the UK seemingly deadlocked on a Brexit deal, and the prospect of a hard ‘no-deal’ Brexit looming ever nearer, what do financial experts believe the impact of Brexit will be on the UK economy and financial markets?

Economists generally appear to agree that Brexit will be bad news. Major institutions like the IMF and OCED suggest that, over the medium term, the UK economy will sacrifice between two and ten percentage points of GDP. This depends on how the UK leaves the EU and what any future agreement with the EU looks like. The worst case scenario being a no-deal exit with no concrete plan.

The worst case scenario suggested by the Bank of England has unemployment rising to between 5.75% and 7.5% and, supported by sterling weakness that will worry central banks, a future inflation rate of between 4.25% and 6.5%, prompting a climb of interest rates to perhaps 4%.

While sterling already prices in a good dose of trouble, a disorderly Brexit would still be a shock to the system, with talk of a drop to a US dollar value of around $1.15, potentially rising from this level post-Brexit. Not surprisingly, if the UK were to stay in the EU, sterling could easily recover by between 10 and 15%.

There has been a steady decline in the UK Equity market relative to the global market index resulting in the lowest relative value in twenty-five years. A disorderly Brexit will most likely shock the market into further decline.  Because the UK Equity market generates most of its earnings from foreign markets, however, levels would be expected to subsequently improve over time.

Trying to predict likely outcomes for UK bonds is a little more precarious than discussing the future of equities because of the sheer range of variables in multiple possible outcomes.  Currently, short-term interest rates in the UK remain low with the gilt yield curve very flat.  As postulated by the Bank of England, should Brexit prove more damaging to growth, short-term interest rates may rise to head off inflation, however, market fears around the deflationary impact of higher interest rates on longer-term growth may prompt long-term interest rates to drop. In this scenario, long-dated gilts might still offer some protection against Brexit, but in this hazardous investment environment confidence in this view, or any other for that matter, is extremely low.