International Finance
Ideas Magazine March-April 2019

Why Brexit is hard to digest

Why Brexit is hard to digest
Indeed, Britain leaving the European Union is majorly linked with uncertainty—a condition that seemed to stoke interest for its seasoned watchers, but certainly not for the rest.

Great Britain has compelled itself into serious trouble. It all started in the summer of 2016, when the United Kingdom voted to extricate itself from the European Union—a miscalculated decision with an untold consequence, perhaps.

But the risk here stretches far beyond what the Brexit impact might be on the country: The possibility of severing formal ties with the European Union would push global markets into a state of paranoia.

By that definition, three years ago the immediate effects of Theresa May’s Brexit proposal on the domestic economy was sensed in two ways. First: The pound fell sharp by 7.6%, which in itself was a disturbing condition for the country since 1985. Second: Investors had started to shed stocks in order to choose a less volatile market investment which nearly resulted in a loss of $3 trillion on a two-day record. Both these consequences seemed daunting, then. While the domestic market is forced to face what will happen in the country or the European Union—the global markets are recoiling at the very thought.

Quilter Investors Head of Investments, Anthony Gillham, said: “For long-term investors it is crucial to take stock of the big picture, however. While uncertainty is clearly a concern for business leaders, the fate of UK listed firms is not totally reliant on the domestic economy. [The] UK large cap companies derive a huge share of their revenues from overseas operations, and many have in fact benefitted from Sterling weakness, which may boost their competitiveness.”

Although this might be true, for International companies that decided to headquarter in the UK to easily access into the European marketers, there could be an inevitable array of drop in profits.

But on the bright side, “risk events with an unknown outcome such as this are a perfect example of the importance of diversification and a global outlook for investors. When one region or asset class faces a period of uncertainty, diversification is an investor’s built-in defence,” Gillham added.

The Brexit fear is spreading like wildfire: “It is not just imports that will be hit by a no-deal Brexit. UK exporters to the EU will face an estimated £7 billion in annual tariff charges on their sales. The administrative costs of the new declarations imposed by the EU will be an estimated £8 billion per year.

“Any attempt to cut tariffs will also risk a backlash from developing nations which currently benefit from the tariff preference scheme for their exports to the UK. This advantage would be wiped out by a unilateral cut in UK tariffs,” Richard Asquith, VP Global Indirect Tax at Avalara, said:

The Bank of England has warned the economy that a no-Brexit deal could cause recession: in its most recent quarterly report, the Bank has slashed this year’s forecast growth from 1.7% to 1.2% because of Brexit uncertainty coupled with a slowing global economy with the Brexit fog “causing short-term volatility in the economic data and, more fundamentally, it’s creating a series of tensions.”

British businesses have earnestly requested politicians to end the disagreement over Brexit and settle for a smooth withdrawal from the European Union. It is imperative to realise that “the lesson here is that UK businesses are going to have to make their own luck after Brexit,” by expanding their vision and ensuring “their finance will stay in the boat with them through Brexit.”

There is reason for businesses in the UK to fear the Brexit spiral, especially as it complicates the withdrawal which is not expected to conclude anytime soon. Fiona Cincotta, senior market analyst, said: “The FTSE is trading higher after another turbulent Brexit night when MPs voted against extending the deadline for Britain’s exit from the EU and broadly supported Prime Minister Theresa May’s Brexit Plan B. The pound’s reaction was swift: dropping to $1.30 against the dollar from $1.319 earlier Tuesday and helping some FTSE constituents gather steam this morning. But in the meantime sentiment has shifted in favour of sterling which has been trading at $1.31 this morning.

“…on closer inspection it becomes clear that she [Theresa May] may not be able to actually deliver on the changes she is proposing. Brussels has immediately slammed the door in the face of a renegotiation with the EC’s President Donald Tusk saying that the EU would not renegotiate the deal.”

Markets don’t appreciate this kind of uncertainty. “It means that numerous permutations still remain, with no clarity about which is most likely. This is not a fork in the road for Brexit, but a spaghetti junction.

“With no reassurance that a stable resolution can be reached, asset prices will continue to reflect the extreme uncertainty that prevails in UK politics. Sterling will remain sensitive to changing rhetoric over the coming days and weeks, and markets will be watching today’s confidence vote very closely indeed.

“On the basis that up until now ‘no deal’ has been treated as a relatively unlikely prospect, the coming weeks could prompt significant shifts in UK asset prices. If the likelihood of a no deal is seen to increase significantly—many analysts were predicting just a 5-10% likelihood of a no deal outcome—then it could move markets,” Gillham concluded. With this, some suggest that “economic players and investors” are looking to restructure their global business plans and uproot jobs from the UK. This is not positive. In fact, the no-confidence vote “is a blow to Prime Minister Theresa May and although she has asserted her conviction that she can still get a deal through Parliament, the path ahead remains extremely unclear.”

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