Whilst Brexit negotiations have dominated UK headlines, there has been a marked improvement in the UK’s public finances. Public borrowing is now a fraction of what it was just a few years ago. Government debt – as a percent of GDP - is finally on a downward trajectory. This is likely to be the main theme of the Spring Statement when released on Wednesday.
The Chancellor seems highly unlikely to spend the windfall immediately, largely because by the time the Chancellor stands up to present the fiscal statement the projections will already be out of date. The evening before the House of Commons will have voted for a second time on whether to accept the Brexit deal the Prime Minister has negotiated.
If the deal is passed the Chancellor’s revenue windfall could get even bigger. The uncertainty caused by Brexit has coincided with a slowdown in spending, investment and the housing market in recent months – all of which generate tax revenue. A vote in favour of the deal should lead to some revival in activity as the UK will smoothly enter a period of transition and negotiations on the final partnership can proceed. The Chancellor could then fuel this uptick in activity by loosening fiscal policy in the Autumn – the ‘deal dividend’ as he has termed it.
In this scenario we would be likely see some pick up in the valuation of small and mid-cap domestically-focused stocks. It might not be such good news for the large cap international stocks because a modest uplift in sterling could depress overseas earnings. It may also not be good news for gilt prices since an acceleration in activity at a time when record high employment suggests the UK is already at full capacity, might encourage the Bank of England to raise interest rates, which in turn would push down gilt prices.
It is possible that the deal does not pass on Tuesday night. Having rejected the deal Parliament will then vote on whether it will accept ‘no deal’ on Wednesday evening. Given votes on former amendments we can be reasonably confident ‘no deal’ will be firmly rejected. In which case, there will be another vote on Thursday asking Parliament whether it wishes to extend Article 50 for a short-period for discussion to proceed. In this scenario, markets are likely to end the week broadly where they start since the state of play would be similar to where we are today. One in which no deal is not acceptable to either side, but the game of brinkmanship looks set to continue until one side bends to a further concession.