Draft Brexit transition deal is unlikely to boost UK stocks

Thought of the day

by Chief Investment Office 19 Mar 2018

Michel Barnier, the EU’s Brexit negotiator, and UK Brexit Secretary David Davis announced on Monday that a draft transition deal had been reached, describing it as a “decisive step.” The transitional Brexit agreement will run from 29 March 2019 until the end of 2020.

While the deal removes some uncertainty regarding the Brexit process, which is positive for sentiment, little in today’s news changes our relatively downbeat view of UK equities:

  • Recent pessimism about Brexit negotiations has weighed on the pound, which was trading 1% higher against the USD after the deal announcement. We expect further sterling gains (we forecast GBPUSD at 1.45 in six months) as less uncertainty allows the Bank of England to focus on reining in inflation. A stronger pound is likely to drag on UK corporate earnings, which are heavily exposed to overseas markets.
  • About half of the UK index is composed of defensive sectors, making it less leveraged to buoyant global economic growth. So, the outlook for UK large cap earnings growth, expected to come in at a rate in the mid-single digits, is weaker than for more cyclical equity markets such as the Eurozone.
  • Uncertainty has lessened but not disappeared. The difficult question of the UK/Irish border must still be resolved, and Barnier emphasized that the transitional deal is conditional on the ratification of the final withdrawal agreement.

These concerns appear to be partly reflected in the market, with the FTSE 100 trading 1.3% lower after the announcement. Within Europe we continue to prefer Eurozone stocks to UK equities.

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