Fri, Dec 25, 2020 – 7:17 AM
[LONDON] The completion of the long-awaited Brexit trade deal comes just as UK markets closed for the Christmas break, but things are set fair for next year when liquidity returns.
The British pound versus the US dollar remains the best indicator of sentiment – and it was about the only market open when the deal was announced on Thursday afternoon in Europe.
It had pushed up to its highest level for two years as speculation mounted that a deal was close.
Sterling is still fundamentally cheap, although it is has stayed so for a very good reason amid the nightmare of seemingly never-ending trade negotiations.
As long as the agreement is ratified by the European Union’s member states and both the British and European parliaments, the pound should head higher toward US$1.40.
But don’t expect a return to the US$1.50-plus levels seen before the 2016 referendum.
The UK economy still has the major handbrake of Covid-19 to overcome, although at least the sometimes distracted Boris Johnson can give the pandemic his full attention now.
Much of the country, including wealthy London and south-east England, are in hard lockdowns, which may continue for much of the first quarter of 2021.
It’s not until the spring, when mass vaccinations will have been rolled out, that any Brexit premium can really be enjoyed.
With the threat of “no deal” put aside, gross domestic product should increase by more than 6 per cent in 2021, according to Bloomberg Economics. That could easily rise if vaccines allow for an earlier lifting of restrictions on economic activity.
The FTSE 100 index was little changed on Thursday but many of its constituents make most of their revenues overseas, so a stronger pound is not their friend.
The FTSE 250 index, which better reflects the domestic economy, has been rising recently, and it should be an outperformer next year.
The big unknown for the economy will be the return of mergers and acquisitions (M&A) and animal spirits in business: If foreign direct investment – once a winning hand for Britain – returns after five long years of uncertainty, the UK equity market could well be the place to be in 2021. That is not a sentence I’ve been able to write for many years.
One important caveat is that financial services have been largely left out of this deal, and a wider settlement between the City of London and the EU won’t be resolved until March at the earliest.
This sector makes up 7 per cent of UK gross domestic product and it’s the country’s highest export revenue earner.
At least there will be no cross-retaliation inflicted on the finance industry if Britain reneges on its agreements in other sectors. And Britain looks to have avoided the so-called “headnote,” which would have allowed the EU to restrict the outsourcing of financial services from the continent to London.
UK government bonds, known as Gilts, have fallen in price this week as expectations of a deal grew and their appeal as a safe haven diminished.
Gilts should steadily widen in spread compared to their European counterparts next year as the European Central Bank is likely to pursue its bond-buying programmes for longer and to a greater extent than the Bank of England (BOE).
Britain has been trapped for half a decade in its internal and external battle to resolve its relationship with Europe. That is not over, but a more promising chapter is about to start.
And even though Europe’s yields will be lower, the BOE will still keep the UK’s interest rates on a short leash for the foreseeable future.
The pound and domestically focused equities should benefit from these benign conditions. Investors will just be relieved to see a possible end to permanent crisis.