Rathbones’ Ed Smith places 30 per cent odds on a “significantly adverse economic scenario” resulting from the UK decision to leave the EU as he argues the Conservatives have no political incentive to soften their Brexit approach.
Trade, financial services and investment are the three key areas the asset allocation strategist is concerned about under Brexit.
Smith points out that economic modelling completed by Rathbones ahead of the Brexit referendum put odds of a “significantly adverse economic scenario” at 10 per cent, but that has tripled.
“This increase is due to knowing the result of the referendum, understanding a higher political will for hard Brexit, upgrading the probability that the EU integrates further after the election of Emmanuel Macron in France, and including a risk that the UK struggles to complete trade deals with other nations in a timely manner,” Smith says.
The high numbers of votes for the Conservative and Labour parties indicates there is no political incentive for the Government to soften its Brexit approach, Smith says, pointing to the fact that the Labour manifesto stated support for leaving the single market.
However, Smith notes less than one in three voters read election manifestos.
Smith says conversations with investors typically focus on trade, financial services and foreign direct investment.
Non-tariff costs are of much more concern to Smith than tariffs, which he says would average 3 per cent under WTO rules. This includes complex regulatory and certification costs, quality assurance and labelling regimes, state subsidies and minimum import prices.
“But this is a longer-term threat: given that the UK is already set up to comply with EU regulation, additional non-tariff costs in the short term would be broadly limited to more onerous burdens of proof.”
Financial services is Rathbones’ biggest concern.
The UK’s trade surplus in services is almost entirely in financial, and other professional and technical services often ancillary to finance, Smith says.
“If the UK failed to negotiate a bilateral agreement that enshrined the continued passporting of its financial services, it is difficult not to envisage a gradual loss of business and investment,” Smith says, pointing out this has knock on effects for commercial property.
On foreign direct investment, Smith says it has been on a downward trend since 2014 and Rathbones does not expect business investment to make a meaningful contribution to UK growth while the “cloud of Brexit hangs over UK commerce”.
“Research suggests the most important drivers of global FDI are market size and agglomeration – a fancy term to describe the benefits when firms and industry networks locate near one another.
A hard Brexit would clearly impact market size but other factors that compel agglomeration in the UK would remain. Investment will not be immune, but again we would not envisage inward investment collapsing in the event of a hard Brexit.”
Government incentives for R&D-based investment to improve the outlook for investment overall, Smith adds.