As Brexit begins, a
slowdown ahead?

Isabelle Mateos y Lago |31-Mar-2017

The government formally began the Brexit process on 29 March. BlackRock’s Isabelle Mateos y Lago explains what this could mean for the UK economy and markets.

The UK’s outperformance among G7 economies in 2016 was a surprise. Yet we see a slowdown on the horizon as Brexit transforms from a debate into a reality. The triggering of Article 50 of the Treaty of Lisbon was the first step in a Brexit process that will be a long and twisting road. After all the uncertainty about how a Brexit trigger will play out for the UK and Europe, the details will start to get thrashed out at the negotiating table.

The UK’s expansion has been fuelled by resilient consumer spending and a weaker pound, which is down 12%1 in trade-weighted terms since the Brexit referendum outcome last June. Investment has been less of a drag than feared as businesses adopted a wait-and-see stance. The labour market has remained robust, with unemployment falling to the lowest level since 1975. Monetary policy support and somewhat reduced fiscal tightening have also played a key part.

UK equities have done well. But much of the FTSE 100’s 19%2 surge since the Brexit vote boils down to a weak pound and rebounding commodity prices flattering the index, given the heavy weight of global banks and miners. For unhedged foreign currency investors, the outcome is less impressive: a gain of 0.4%3 in USD terms. See the chart below.

UK and developed market equity performance pre- and post-Brexit vote

UK and developed market equity performance

Sources: BlackRock Investment Institute and Thomson Reuters Datastream, as of 3/24/2017.

UK outlook

The outlook for UK assets from here will be driven by slowing domestic conditions, offset in part by the global reflationary backdrop. Political and headline risk will remain high. We see the possibility of a snap election before the next UK general election is due to occur in 2020. With Article 50 now triggered, running commentary on what Brexit means could stir more volatility, primarily in the pound but also possibly in some export- and import-sensitive equity sectors.

Most analysts expect a deeper UK growth slowdown from here. Yet our BlackRock GPS, which combines big data signals and real-time economic data to give a near-term handle on the growth outlook, suggests the current year-ahead consensus view is still too optimistic. Inflation has jumped, in part due to a weaker currency. Consumer prices rose at a 2.3% annual rate in February, driven by higher food and fuel costs. Higher inflation has pushed real household wages into negative territory, a risk for future consumer spending.

Corporates hold the key

We believe the outlook for corporate investment is key. Recent UBS survey data4 shows one-third of eurozone corporates expect to slash investment in the UK when exiting the EU becomes more concrete. More than 40% expect to reduce UK-based capacity significantly, according to the UBS survey. For now the Bank of England (BoE) is likely on hold given that inflation is above its target and this is our baseline case for the foreseeable future, though of course this could change if the economic outlook were markedly revised and we could then see the pound break out of the 1.20-1.25 range in which it has been trading against the US dollar.

A more stable outlook for commodities and the global reflationary environment bodes well for the FTSE 100 in 2017. The outlook for UK banks and insurers is less clear due to the uncertain effect of the Brexit negotiations. We favour shorter duration in government bonds, as valuations among long-term Gilts appear rich. Likewise, UK credit looks expensive. Corporate bond spreads have been pushed tighter by a faster pace of BoE purchases than had been expected.

Property markets were an area that many expected to be hardest hit by Brexit. So far price appreciation has slowed rather than reversed. While UK housebuilder share prices remain significantly below pre-referendum levels, a weaker sterling has stirred overseas appetite for UK residential property. Still, we are also cautious on UK real estate relative to the sector in other countries, as the recent “bounce” in valuations is unlikely to be sustained and may well unwind over coming quarters, we believe.

Isabelle Mateos y Lago
Global Macro Investment Strategist at BlackRock
Isabelle Mateos y Lago is a global macro investment strategist in the BlackRock Investment Institute.
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Hugh Gimber, a Multi-Asset Investment Strategist within the BlackRock Investment Institute, contributed to this post.

1Refers to period between June 23, 2016 and March 24, 2017. Source: Thomson Reuters Datastream.
2Refers to period between June 23, 2016 and March 24, 2017 in GBP terms. Source: Thomson Reuters Datastream.
3Refers to period between June 23, 2016 and March 24, 2017 in USD terms. Source: Thomson Reuters Datastream.
4UBS Evidence Lab: How do Eurozone firms react to Brexit and other political risk? 17 March, 2017.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 16 March and may change as subsequent conditions vary.

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