The United Kingdom: Brexit eclipsed by coronavirus

Five years ago, on 23 June 2016, the United Kingdom held a referendum on leaving the European Union. One and a half years after the UK’s official departure from the bloc, many questions still remain unanswered. Overshadowed by the coronavirus crisis, Brexit has so far delivered mixed results. The UK economy is currently on the road to recovery.

On 23 June 2016, the UK voted to leave the European Union (EU). What ensued were several years of domestic political quarrels and rocky negotiations with the EU about a withdrawal agreement. Boris Johnson’s election victory at the end of 2019 brought a certain level of stability, but soon after, the UK was hit by the full force of the COVID-19 pandemic. The EU-UK trade deal did not come into force until the start of 2021, at the height of the second wave of the pandemic. The effects of Brexit on the real economy will therefore really only start to become apparent in the coming quarters. At present, it is still difficult to separate the economic impact of Brexit from the impact of the coronavirus pandemic, because both coincided to a large extent.

It is fair to say that Brexit has not spelled the end of the world for the UK. Trade between the UK and the EU slumped at the start of 2021 and there are anecdotal reports from individual companies of frictions, but trade relations have certainly not collapsed. However, five years after the referendum, Brexit is still causing political turmoil. At the heart of the issue is the implementation of the Northern Ireland Protocol. While both sides agreed to this protocol as part of the withdrawal agreement, the UK has been reluctant to follow through in practice. Brexit is therefore unsettling not only EU-UK relations but also domestic politics (think of the Scottish independence movement) and even relations with the US.

Economic recovery thanks to immunisation success

The UK has been very successful with regard to the rollout of its COVID-19 vaccination programme. This has enabled the country to ease most of the restrictions that were imposed to contain the spread of the virus. As a result, the UK economy has been recovering strongly since the spring of 2021. This is especially true for sectors that had been hit hard by the pandemic, for example the service sector. Consequently, pound sterling has been the second-strongest G10 currency in the year to date, after the Canadian dollar. When analysing the entire period since the Brexit referendum, however, sterling has been the weakest of them all, having depreciated by around 6 per cent against the US dollar and by around 10 per cent against the euro. The London Stock Exchange’s FTSE 100 share index has gained around 35 per cent (including dividends), in local currency terms, over the five years since the referendum, while the EURO STOXX 50 index and the German DAX index each advanced by more than 50 per cent over the same period.

We expect that the economic upturn in the UK will continue over the coming months. But uncertainty is growing again as coronavirus infections in the UK are back on the up due to a surge in cases of the Delta variant that was first identified in India. The UK government responded to this trend by postponing the last stage of its reopening roadmap by four weeks. This decision should have only a minor impact on economic growth, as Union Investment does not anticipate a reversal of the steps that have already been taken towards reopening. Despite the spread of the Delta variant, hospital admissions are not overly high compared with previous waves of the pandemic.

Delta variant thwarts lifting of last remaining restrictions; concern about renewed lockdowns growing again

Sequence of the unlocking steps (selected measures)

Delta variant thwarts lifting of last remaining restrictions; concern about renewed lockdowns growing again
Source: Union Investment, as at: 25. June 2021

COVID-19 remains a key factor for the capital markets

COVID-19 remains a key factor for the capital markets
Sources: Bloomberg, Union Investment, as at 23 June 2021.

All in all, the opportunities for the UK economy currently outweigh the risks. The coronavirus pandemic left deep scars in 2020 when the economy shrank by 9.8 per cent – more sharply than in most other industrialised countries. Union Investment’s economists expect that the UK economy will grow by a healthy 7.0 per cent in 2021 and by 5.6 per cent in 2022. This encouraging growth on the back of economic reopening measures has contributed to a rise in the rate of inflation to 2.1 per cent in May 2021. The Bank of England confirmed yesterday that it regards this inflation trend as a temporary phenomenon and does not intend to change its monetary policy strategy. Union Investment believes that the bank will not raise its key interest rate until 2023. But if macroeconomic data and inflation significantly exceed expectations over a prolonged period, the Bank of England will probably take action sooner and raise interest rates in 2022.

UK equity market now valued favourably

For years, UK equities have been trailing the global market. But Union Investment believes that they should no longer be underweighted. The UK equity market is now valued attractively, although mid-cap stocks (FTSE 250 index) are preferable to large caps (FTSE 100 index). Firstly, mid caps typically perform better than blue-chip stocks during an economic upturn. Secondly, even UK large caps are currently valued affordably in historical terms. However, the relatively high weighting of the energy sector (around 10 per cent) compared with other regional markets poses a certain risk. Thirdly, Union Investment expects bond yields to rise globally in the coming years. This would be particularly unfavourable for UK large caps.

As at: 25. June 2021.