No Brexit plan – but a clearer destination - J.P. Morgan Asset Management

No Brexit plan – but a clearer destination

Contributor Stephanie Flanders

Theresa May has given much more detail than previously on what the UK’s negotiating objectives will be when it starts on the road out of the European Union (EU). The speech did not answer all the questions that Britain’s business community and trading partners might have, or remove all of the uncertainties hanging over Britain’s future relationship with the EU. But that was never likely or practical. In laying out the government’s 12 guiding principles for the upcoming negotiations, May did remove some key question marks about the government’s approach, and promised that both houses of parliament would get to vote on any Brexit agreement. This seems to have reassured investors. The pound was more than 2% higher against the dollar shortly after the speech, though the FTSE 100 fell.

The key points for investors are:

  • The UK will NOT continue to be a member of the Single Market after leaving the EU, because it will not accept free movement of people into the country or any control over UK laws by the European Court of Justice (ECJ).
  • The UK will seek tariff-free access for goods to the EU, as is offered by membership of the EU Customs Union. But how this is achieved is up for discussion, and the UK will NOT accept the common external tariff or other limits associated with full membership of the customs union.
  • The UK is aiming to have transitional arrangements for individual sectors, after the Article 50 process is concluded, to prevent a “cliff-edge” for businesses and consumers. How long these arrangements would last would depend on the sector and be subject to negotiation, but they would NOT be open-ended and they would happen after the formal exit agreement had been reached.

Instead of being in the Single Market, May said she wanted the UK to seek “the greatest possible access to the Single Market through a new, comprehensive, bold and ambitious Free Trade Agreement”. She said this could mimic elements of existing Single-Market arrangements in industries such as cars and financial services, but she repeated that the UK would not be seeking to hang on to bits of EU membership, as some had hoped.

There were plenty more points of interest in the speech, notably the commitment to seeking to maintain a common travel area with the Republic of Ireland and the promise that devolved powers for Scotland and other nations within the UK would not be taken back by Westminster and might even be increased as part of the process of leaving the EU.

However, the most important questions for investors will relate to the practical details of what May is proposing - and whether any of this will be politically acceptable to the other countries of the EU.

The rejection of the ECJ and the comments on immigration are especially important for the business community.

  • On the ECJ, many involved believe that other EU countries will not be willing to have the City of London remain the dominant provider of certain financial services to EU firms if the UK is not willing to accept some EU-level jurisdiction over UK financial institutions. If that view is correct, then May is not going to realise her stated goal of replicating - or nearly replicating - the conditions that UK-based financial services companies enjoy now within the Single Market.
  • Many UK businesses rely on immigrant workers - skilled and unskilled. May suggested that the government would look more favourably on the first of those than the second, but there was very little detail. She also claimed that the high level of immigration in recent years had pushed down wages for unskilled workers in the UK. This has not been the official Treasury line to date, and could be problematic for companies who have grown dependent on cheap migrant labour.

The positive market reaction to the speech suggests that any concern about the content of the speech has been outweighed by relief that it was delivered at all. There is plenty about the Brexit process for UK businesses to worry about. The PM insisted that “no deal was better than a bad deal” - and she admitted that a good deal was not a forgone conclusion. But we do now have more clarity on what the government is hoping to achieve - and an official assurance that transitional arrangements will be made. That, along with the prime minister’s more conciliatory tone towards the rest of the EU, is likely to be positive for UK assets, at the margin. However, we retain our view that large-cap UK equities overall look less vulnerable to Brexit risks and are generally more favourably priced in the current environment than either small- and mid-cap UK stocks or many other developed equity markets.

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