“Hard Brexit” is the most likely scenario for the UK leaving the EU, according to the Bank of Singapore. Such an outcome will result in a further decline of the pound sterling and high volatility of UK equities, with no significant potential for upside, according to a research note from the bank.
The pessimistic view, which gives “hard Brexit” a probability of 65% and an even more radical “very hard Brexit” a probability of 35%, was prompted by UK Prime Minister Theresa May’s January speech outlining the government’s intentions around the exit of UK from the EU, according to James Cheo, investment strategist, the author of the report. The view is likely to set the tone for Asian investors’ outlook on the future of Europe and the UK.
The sterling will most likely decline to the £1.15-£1.20 range with respect to the US dollar by the end of 2017, and will be plagued with volatility, according to Cheo. The currency’s decline from the current rate of £1.25 will likely lift inflation and decrease real income, but stronger exports and a policy stimulus should ward off recession.
“The UK would likely go through a period of weaker and more volatile growth” and experience “bigger trade and budget deficits”, Cheo wrote in the report.
The “hard Brexit” scenario assumes some form of free trade arrangement with the EU after the formal exit, likely involving industry-by-industry deals. “Very hard Brexit” predicts trade barriers, restriction on the flow of capital and people, no trade deal with EU, as well as big trade and fiscal deficits, likely resulting in a recession. The sterling would in that case drop below £1.15 for a prolonged period.
Looking at the performance of UK equity funds, one might think Cheo’s view is overly pessimistic. UK equity funds registered for sale in Hong Kong have recorded an average growth of 6.0%, 5.8% and 23.7% on the 3-month, 6-month and 1-year basis, respectively, as of 9 February.
“The market hasn’t yet priced in the effects of the hard Brexit to the full extent,” Cheo told FSA. Investors should consider hedging and rebalancing strategies before Article 50 is triggered, he advised.
Three-year performance of the five largest UK equity funds in terms of AUM:
Source: FE. The universe is funds available for sale in Hong Kong