Monica Defend Head of Global Asset Allocation Research Pioneer Investments

With the triggering of Article 50 of the Lisbon Treaty, the UK has officially started the two-year process that will drive the country out of the European Union. The six-page letter was delivered to Mr. Tusk, the president of the European Council. Let’s sketch a possible timeline of the next check points.•  Tusk will promptly send (within few days) a communication to the 27 EU members about the notification and a proposal on the negotiation guidelines, which has been already prepared.• A discussion and the approval of the guidelines will take place at the next EU summit on April 29th; formal talks will start in May. The chief negotiator for the EU is Michel Barnier (former EU commissioner for Internal Market and Financial Services).

•  The guidelines will contain the shared EU position on market access, on the UK’s trade status after its exit and on principles regarding the exit. This latter part will regard the respective rights of EU citizens in UK and of Britons in the EU and the obligations resulting from the involvement of the UK in multiyear common plans.

•  One important theme on which EU leaders will have to agree is the sequencing, i.e., if the part regarding rights and obligations is tackled first and trade negotiations only start thereafter or if all talks are to be carried out in parallel.

• The UK Parliament in the meanwhile will likely start discussions on the so-called Great Repeal Bill.

• The two-year timer has just started to tick. The deadline can be only postponed by unanimous decision.

How will the Brexit negotiations evolve?

The statement by PM Theresa May about no deal being better than a bad deal for Britain has been widely criticised. The widespread sentiment is that a hard Brexit could be a real tragedy, from an economic point of view, for the UK.

Unfortunately, initial positions from both parties do not support much optimism for a “soft” and smooth negotiation process, with the no-deal-better-than-bad-deal attitude on one side and with unreasonable – and perhaps ungrounded – financial demands on the other. However, chances for a good final compromise are still non-negligible, as it is in the overwhelming interest of both parties to achieve this.

Apart from the “bilateral” contrasts, British internal political events may contribute to making the talks proceed even less smoothly.

In this regard, we refer to the fact that

1) Brexit secretary David Davis has assured that the UK government would respect a Northern Ireland vote for Irish unification

2) The Scottish parliament formally endorsed Nicola Sturgeon’s call for a second referendum and

3) Some of the legislative and political power travelling from Brussels back to the UK must be managed, either by centralising it in London or devolving it to the capitals of UK states, which might be a source of friction.

What will be the consequences of the bargaining attitude of the EU?

The number and the complexity of the links between the UK and the EU and the contribution of the UK to the EU in terms of military power and global perspective suggest that, at least from an economic point of view, it would be in the best interest of Europe too to reach a “soft” Brexit agreement.

However, political factors are likely to play a prominent role in shaping EU attitude during the negotiations, since, if European institutions show that leaving the EU is without negative consequences, this would likely be the end of European unity. Our opinion is that the noisier the political situation will be in EU member states, in terms of populist and anti-EU parties finding consensus, the tougher the EU attitude towards British representatives will be. On a more optimistic note, anyway, the results of the Dutch elections and the most likely outcomes of the French and German votes seem to be going in a more favourable direction.

What will the economic and market impact of the Brexit be? How is the UK economy reacting now?

It is important to distinguish short, medium and long-term consequences. As to the short run, the positive momentum will likely slow down over the next two years: the main driver will be the erosion, due to inflation, of the purchasing power of private agents, as a consequence of the strong depreciation of sterling. This negative evolution of what has been so far the main driver of the good performance of the British economy will be partly counterbalanced by a boost to net exports, which is already showing signs of improvement.

What will be the medium-term consequences?

The medium-term can be affected by consequences more closely related to Brexit agreements. The brightest example is very probable loss of UK passporting rights for financial services towards the EU, which will trigger a movement of jobs from London to Ireland and continental Europe, the withdrawal of part of the foreign investments made in the British financial industry and a worsening of the UK’s trade balance as a consequence of lower financial services exports to the EU. This structural worsening of the trade balance will also likely cause further movements on the sterling, with the risk being strongly skewed towards depreciation.

And what happens after the divorce? What will the role of UK be in the future?

It is obviously difficult to forecast in the distant future, but one consideration can be made: the UK must change its growth model from the current one – which benefitted a lot from being a country with a particularly high-quality institutional setting inside the EU – where it has specialised (also) in being a sophisticated point of entry to the single market. It is also clear that the UK will benefit less than in the past from the inflow of a skilled labour force from abroad. Therefore, it is likely that, even though not dramatically, the potential growth rate of the UK economy will diminish.

What are the Brexit investment implications from a multi-asset perspective?

From a multi-asset investing perspective, we don’t think that Brexit is a risk that weighs on our global investment outlook, that overall remains constructive for risk assets. On the contrary, we believe that the Brexit negotiations will make the UK markets and currency more volatile and exposed to political events and therefore we prefer to maintain an agnostic positioning on the UK markets for the time being.

We also maintain a negative bias in the medium to long term due to the possible economic implications of Brexit on the growth potential of the UK economy.

The post ‘Potential growth rate of the UK economy will diminish’ appeared first on International Finance.

Nigel Green

Investors need to prepare now for three key issues ahead of Britain formally starting divorce proceedings with the EU. UK Prime Minister Theresa May is expected to trigger Article 50 of the Lisbon Treaty on March 29.

By this time next week, Britain will have officially started the process of unravelling itself from the European Union. This is one of the most complex negotiations in political history with global consequences, and as with most divorce proceedings, it is unlikely to be completely smooth sailing. As such, investors need to ensure their portfolios are ‘Brexit-proofed’.

With the clock ticking on the starting pistol being fired, investors need to prepare now for three key issues.

First, be prepared for increased market volatility.  Uncertainty creates tidal waves of volatility across financial markets – and the Brexit negotiations represent a huge unknown.

Against a backdrop of growing volatility, investors need to ensure that their portfolios are truly diversified. This means investing across geographical regions, sectors and asset classes. Those with a well-diversified portfolio are always best-placed to mitigate risk in times of market turbulence, and best-placed to take advantage of the opportunities.

UK assets are likely to feel the heat. Investors should consider taking precautions against the potentially significant adverse effects of Brexit on UK assets, which they can do by increasing exposure to overseas investments.

Second, be prepared for sterling to experience further swings.  The pound fell 10 per cent against the dollar in the week after the referendum to leave the EU. Similarly, it dipped this week when Theresa May confirmed the trigger date of Article 50.

Sterling is currently considered cheap, considering the underlying buoyance of the British economy, now forecast to grow 2 per cent in 2017. This is a buying opportunity for some investors.  However, with an enormous question mark hanging over the negotiations, and the creeping inflation, the pound’s current low value might not last.

And third, be prepared for the far-reaching impact of higher UK inflation and higher interest rates. This week, inflation hit its highest level in more than three years – and smashed the Bank of England’s official target.  This has raised expectations that interest rates could be hiked sooner rather than later.

This new landscape will present a new set of winners and losers for investors. A good financial adviser will help them select the right investments and, crucially, at the right time.

A lot has happened since the EU referendum in June 2016, and today the economy is facing a very different set of issues.  The economic landscape will continue to shift significantly during the two-year negotiation period.  Investors need to remain aware and agile and ensure their portfolios are Brexit-proofed.

Nigel Green is founder and CEO of deVere Group

RELATED STORIES

‘Dutch election result hint at more constructive approach to policy’

May likely to deny Scottish independence referendum

Merger of LSE & Deutsche Boerse in doubt

The post Article 50 countdown: Investors need to prepare for 3 key issues appeared first on International Finance.

Don Smith

October 27, 2016: Despite a run of better than expected UK economic data since the Brexit vote – including 0.7% second-quarter expansion, beating estimates – financial markets are increasingly concerned about the outlook for the country’s economy and its currency.

This can be seen most dramatically in the sterling’s plunge on the foreign exchanges, which shows little sign of abating. On a trade-weighted basis, the pound declined 15% between the June 23 referendum and October 12, while it has moved from 0.76 to 0.90 versus the euro over the same period.

Some bounce back from this sharp slide appears likely, but there’s little doubt that the sterling’s underlying trend remains firmly downwards.

Although the UK economy should steer clear of recession, the anticipated broader effects of Brexit may soon become more evident. As a result, growth is expected to slow next year.

Consequently, the Bank of England (BoE) may cut interest rates further to provide additional support. The next move would likely be a decrease to 0.1% (from 0.25%), but this might not occur until mid-2017.

With interest rates already so low, and an uncertain path ahead for the economy, the BoE will exercise caution when deploying the dwindling number of arrows in its quiver. It will therefore likely attempt to influence interest rate expectations ahead of any actual move, continuing to issue a very dovish message to the markets.

While inflation is expected to keep rising, the BoE will continue to regard this as a short-term phenomenon, which doesn’t challenge the longer-term low-inflation outlook.

At the same time, the sterling’s steep fall was largely unexpected. The pound is being driven by psychological forces, technical moves and speculative reasoning, all of which can be especially volatile and therefore very hard to predict.

The significance of the UK’s decision to leave the EU, and very likely the EU single market, is immense. According to leaked Treasury documents, a so-called ‘hard Brexit’ could cost the UK up to €73 billion annually, leading GDP to underperform by as much as 9.5% in the coming 15 years.

It’s worth noting that the economy is highly dependent on trade and that, in contrast to the euro, the pound operates without the protection of a solid current account position. With the potential to fall a further 5-10%, sterling is thus left hugely exposed as we move into a period of major change for the UK’s network of trading relationships.

As far as its impact on the domestic economy is concerned, this is something of a double-edged sword: good for exporters but bad for consumers, whose spending power will likely weaken due to the effect of a short-term burst of higher inflation as import prices increase.

While there may be a backdrop of solid economic data, sterling remains vulnerable due to the current account position of the UK, which runs a deficit of about 7% of GDP – by far the largest in the G20 and, historically, the largest on record.

This deficit reflects, in the simplest terms, the fact that importers have to sell sterling in order to acquire the foreign currency that pays for goods and services sourced overseas.

As a result, a huge amount of sterling flows into foreign currency markets due to the sheer volume of UK imports in relation to exports. This, in turn, makes sterling’s value in the foreign exchange markets heavily reliant on the purchase of UK financial assets by overseas investors, who have to then swallow the loss.

Without these purchases, the value of sterling would fall even further. BoE Governor Mark Carney aptly captured this sense of vulnerability in his pithy comment about sterling relying on the ‘kindness of strangers’.

Sterling consequently now appears more vulnerable than any other major currency to investor sentiment.

In search of reasons for the pound’s recent plunge, the early October announcement by Prime Minister Theresa May that Article 50 of the Lisbon Treaty would be signed by the end of the first quarter of 2017 surely helped focus investor sentiment on the actual exit event.

Brexit now looks likely to happen no later than the second quarter of 2019 – although, subject to agreement with the rest of the EU, the deadline could conceivably be extended. Given the current rhetoric from key EU politicians, however, there are few signs that the bloc’s attitude to negotiations will soften.

It’s little wonder that markets are increasingly fearful.

Indeed, sterling’s recent plunge may prove just a harbinger. Today, the UK could well be enjoying the relative calm before the real storm that lies ahead.

Don Smith serves as London-based Chief Investment Officer at Brown Shipley, a member of KBL European Private Bankers. The statements and views expressed in this document are those of the author as of the date of this article and are subject to change. This article is also of a general nature and does not constitute legal, accounting, tax or investment advice.

The post Brexit: Sterling appears more vulnerable than any other major currency appeared first on International Finance.