On Monday the UK’s Brexit secretary David Davis and EU negotiator Michel Barnier agreed a transition period to run from 29 March 2019 – the date the UK is set to officially leave the EU – until 31 December 2020.
Both hailed the breakthrough as “a decisive step” in Brexit negotiations, but Barnier was quick to add it “was not the end of the road”. Several issues still remain unresolved, not least what to do about the Nothern Ireland border.
The agreement affords EU citizens arriving in the UK between the outlined dates the same rights as those who arrive before Brexit and the same will apply for UK citizens living in Europe.
It also enables the UK to negotiate its own trade deals during the transition period and to still be involved in existing EU trade deals with other countries.
Following the announcement on Monday, two and 10-year gilt yields rose to 0.86% and 1.5% respectively, before falling back slightly. Sterling rose to $1.405 against the dollar and the euro fell to 87p against the pound. On Tuesday, the 10-year gilt yield had fallen slightly to 1.44%.
Clearer for businesses
David Page, senior economist at Axa Investment Managers, said the announcement gave British businesses a clearer view of their operating guidelines for nearly the coming three years, which is likely to be sufficient for some to make investments in the UK.
He said: “While business investment growth has stagnated in recent quarters, despite accelerating profit growth and strong global activity, we now expect to see some increase in activity. It should also slow UK business ‘contingency measures’ or investments overseas.”
Sacha Chorley, multi-asset portfolio manager at Old Mutual Wealth (OMW), agreed the transition period provides breathing room for businesses, but he said it does not answer many of the fundamental long-term challenges around Brexit’s impact on business, which continues to prevent many from making big investment calls.
He said: “This marginal clarification may spur some business leaders to deploy capital, but for the most part we expect firms will continue to hold investment back until there is proper long-term clarity over the UK/EU relationship and the UK’s global trade position.
“The fact the UK can negotiate trade deals with other countries during the transition period will also be something that markets will watch closely. Favourable agreements with certain jurisdictions could provide a major boost to industry and we may see expectations of future trade priced in to certain assets. Equally, there could be a detrimental knock-on effect if there is a failure to replicate existing trading arrangements.”
Bank of England
Axa IM’s Page also noted the agreement could have some implications for the Bank of England (BoE), which is due to publish its next Monetary Policy Committee (MPC) meeting minutes on Thursday.
Page said: “While we expect no change at this week’s meeting on Thursday, this removal of downside risk makes it somewhat more likely that the BoE could tighten policy at its next meeting in May, ahead of our current forecast of August.”
In terms of the impact on the BoE’s outlook, OMW’s Chorley said: “While the news is unlikely to alter their near-term outlook, Carney has made no secret of the fact that the bank is nervous about the potential de-stabilising impact of Brexit.
“As we get more details about the outlook for the UK economy at the end of 2020, bond markets will be looking for specific indications of how Brexit developments are impacting on BoE thinking, with the MPC’s commentary also likely to be an important factor in sterling rate markets.”
UK equities
Bill McQuaker, multi-asset portfolio manager at Fidelity International, said while investors should view the agreement as a positive development for domestically-exposed UK companies, the FTSE 100 has significant exposure to overseas earnings, meaning a stronger pound is a headwind.
But, McQuaker added there are opportunities in UK equities as a whole.
“Most fund managers are underweight the UK on the back of Brexit-related risks. Those risks have not gone away – a bad deal would still be negative for the economy – but with the status quo now in place for at least another three years, and the UK traditionally a defensive market, UK equities might begin to look more attractive again.”
