Head - EMEA Investment Strategy
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While the EU has granted the UK an extension to its membership, uncertainty over British politics and asset prices looks set to persist.
Our base case that a so-called soft Brexit can be agreed in the coming months remains intact. This follows the "flexible extension" that the EU granted at the eleventh hour. However, the UK faces an extended period of relative political instability that could stretch beyond the revised deadline of 31 October.
Our base case is predicated on the fact that MPs have indicated that they don’t want a ‘no-deal’ exit and would prefer to find a solution that avoids another referendum. Discussions between the two main parties are still ongoing, and are outwardly more constructive than anything seen to-date. So, European Council President Donald Tusk might yet get his wish for the UK to "not waste this time".
Four broad objectives seem to have been agreed: respect for the 2016 referendum result; that the UK must leave with a deal; protection for jobs and national security; and an end to freedom of movement. Early indications also are that Prime Minister Theresa May and Labour leader Jeremy Corbyn might be moving towards having a customs union arrangement with the EU. This would eliminate the thorny Irish border question by having the same import quotas and custom duties within both the EU and UK.
It might secure a successful Brexit before Halloween too, given Mrs May’s restated aim to leave the EU as soon as possible. This would be preferable because if Brexit is not achieved by 22 May, then there is the added challenge of EU parliamentary elections that might attract strong support from newer anti- and pro-Brexit parties and further polarise the political debate.
While a ‘no deal’ hard Brexit, with the potential for an immediate economic hit, is now less likely, the UK faces ongoing domestic political uncertainty that is likely to weigh further on corporate and consumer confidence. That is because neither the Conservative Eurosceptics nor the Labour Remainers have yet achieved their aims. In addition there is the spectre of a snap election – unlikely but possible – being won by the Labour party, who under Mr. Corbyn would be expected to adopt unorthodox economic policies.
So although some of the immediate uncertainty has lifted following the extension being granted by the EU, political factors will continue to weigh on investor sentiment, and limit the potential for sustainable further strength in Sterling which is key barometer for Brexit.
UK equities are well supported by reasonable valuations. However, we advise investors not to chase this market as the trading conditions will be volatile, but rather to focus on specific areas of the market such as large-caps, high dividend yielders, and high overseas earners.
Citi Private Bank remains neutral UK large-cap equities and underweight UK investment grade corporate bonds.