Brexit means lower growth and higher inflation for the UK

During the Autumn Statement to Parliament on November 23rd, Chancellor Hammond detailed the impact of Brexit for the UK. Lower growth, higher inflation and deteriorating public finances are to be expected for the coming years. The home-made slowdown, due to a drop in productivity and immigration, combined with rising inflation after the fall in the British pound, has important implications for asset allocation.

Firstly, Gilt yields appear vulnerable. In the aftermath of the UK referendum, bond yields appear to have troughed. The outcome of the US elections and supportive economic data since then have placed further upside pressure on international bond yields. In addition, domestic risks – linked to the rise in inflation following the GBP depreciation and the deterioration in public finances – are not a welcome development: the debt-to-GDP ratio is now expected to rise above 90%. Clearly, the UK government has chosen not to ease fiscal policy but rather to acknowledge the strongly negative impact of Brexit on revenues.

Second, the depreciation of the GBP might not be over, in particular against the EUR. In order to reduce the significant current account deficit (6.1% of GDP), a further decline in the value of the British pound is likely. This is particularly true against the EUR, as most direct competitors operate in this region and the biggest chunk of the deficit stems from there. From a medium-term perspective, there is further room for depreciation as the decline in the GBP vs. EUR appears limited so far (only 5% compared to its 10y average).

Finally, among equities, UK small- and mid-caps appear vulnerable, at least in relative terms. An underperforming domestic UK economy on a global scale, expensive valuation and a detrimental sector composition effect (less Banks and Energy, more Real Estate and Consumer Discretionary vs. large-cap indexes) represent a significant obstacle.