This article was written by Jasper Lawler, Senior Market Analyst at FCA regulated broker London Capital Group Holdings plc (LON:LCG).
Markets have priced in Article 50
Markets have been taking a more positive view of British assets since Theresa May’s Brexit speech. Even after the Brexit bill was passed by MPs, the British pound and gilt yields are probing six-week highs. The FTSE 100 is lower mainly as a function of the stronger pound but remains close to record highs.
The British government deliberately made the Article 50 bill very short and specifically about starting the exit process. Prime Minister Theresa May announced in PMQs that the government will release its whitepaper about what to do once the process of leaving has officially started.
Politicians kicked up a fuss about not knowing the details of government plans but ultimately voted the same way as the British public. The pound has been rising despite a general understanding that the bill will pass, suggesting the market has now priced in that the UK will leave the EU.
The whitepaper could turn markets red
There is good chance that this is just fleeting optimism before the next inevitable sell-off when Brexit uncertainty kicks in. If the positive opinion rested on the possibility that parliament could scupper Brexit or at least delay it then the British pound could be set to roll over.
We believe the biggest near term risk is the ‘Hardness’ of the whitepaper. Fears of a ‘hard Brexit’ are a risk to business sentiment and investment. The ‘hard Brexit’ risk will be laid bare when the government releases its whitepaper.
If the overall tone of the bill is too “hard” then investors could dump Sterling as well as Brexit-sensitive sectors of the stock market. Sectors that fell precipitously after the Brexit vote such as homebuilders and domestically-exposed retailers might be in the firing line. Bank stocks could come under pressure if an equivalent to passporting is not given priority in the whitepaper.
Bank of England should take a backseat
The Bank of England monetary policy decision, minutes and the inflation report on Thursday could have had a very different tone if the parliament had voted against the British people, but it didn’t. We believe the Bank of England will keep its policy stance neutral.
There will likely be some improvement to growth forecasts but it wouldn’t be a surprise to see the BOE maintain its inflation forecast. Keeping the inflation forecast would give the meeting a hawkish tilt, but overall interest rates are playing second fiddle to politics. Mark Carney and co will want to take a backseat while many political questions remain unanswered.
Fleeting optimism eventually permanent
We are taking a more positive medium term view over the consensus. Having rejected Single Market membership, Theresa May has added some clarity on how the UK will approach negotiations with the EU. A “new, comprehensive, bold and ambitious free trade agreement” with the EU could mean business investment increases rather than decreases.
More certainty (or less uncertainty!) over the Brexit process in concert with a resilient British economy suggests Sterling is undervalued at current market prices. The market has been pricing in disaster, while anything is possible, we think a Brexit catastrophe will be averted.