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The month of March heralds the beginning of the negotiations of the future trading arrangements between the EU and the UK. The respective published negotiating mandates highlight clear disparities, most notably surrounding the EU demand for ‘level playing field’ commitments, ECJ oversight and access to UK fishing waters in return for low friction access to the single market. Given the UK government mandate for self-determination and the size of the Conservative majority, the prospect of a WTO based trading relationship likely yields relatively small further incremental economic damage (and possibly positive political capital) for the UK. Both the EU and the UK will lose from a no deal outcome, but given the diplomatic trajectory and based on what we know now, the most likely scenario is a no-deal outcome, with the UK reverting to WTO terms on January 1, 2021, and with the two sides continuing to engage with each other to possibly strike a deal some time (2, 3 years) later.

There is of course a further dimension to the EU/UK trade talks: the active participation of the US in negotiating trade terms with both the UK, and most likely the EU concurrently. Indeed, for the UK, the economic damage of a no deal can, to a lesser degree, be offset by trade gains with the US, Japan, Australia and New Zealand. For the EU, an independent, potentially low tax, zero tariff UK on its doorstep would be the worst possible outcome, and a more confrontational dialogue with the US is a further negative permutation. GBP is still looking fine over a 12-18-month horizon, but in the coming months, it will need to weather some bad news on trade.

The UK officially left the EU at the end of January and likely needs to adopt a proactive fiscal stance to guard against the scenario of no deal with Europe. The (perhaps impromptu) cabinet reshuffle in February, installing Rishi Sunak as Chancellor of the Exchequer, comes with expectation of fulfilling this requirement and the upcoming Budget (March 11th).

The above article is an extract from our regular fund manager commentaries.

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