By Anna Isaac and Pat Minczeski
With two Brexit deadlines already passed and a third expected to
be extended, the uncertainty that has weighed on the economy and
financial markets for three years looks set to drag on.
While lawmakers backed Prime Minister Boris Johnson's Brexit
deal this week, they didn't approve his accelerated timetable,
making a departure from the European Union by Oct. 31 unlikely and
extending a political deadlock that has eroded economic growth and
business investment.
"I can't think of another sovereign in our rated universe that
has withdrawn from such an integrated trading relationship," said
Colin Ellis, U.K. managing director at credit-ratings company
Moody's Investors Service. "There are a few places -- like business
investment, like the exchange rate -- where we can look at the
behavior of some of those variables to have a sense of the
effect."
A Subdued Pound
Since the Brexit referendum in 2016, the pound has lost about
13% of its value against the U.S. dollar and briefly touched
multidecade lows in recent months. On Wednesday evening, one pound
bought $1.2914. Sterling has also depreciated against the
currencies of its major trading partners, including the EU and
China.
That is good news for some of the U.K.'s biggest companies,
which generate a substantial portion of their revenue overseas,
because their foreign income is worth more in pounds.
For manufacturers whose exports become more competitive because
of the cheaper pound, the benefits have been largely muted by the
higher costs of imported parts and other costs.
Despite the sharp drop in the value of the pound immediately
after the referendum result, some foreign-exchange strategists and
traders say the currency has been largely rangebound in recent
years.
"There has been no trend in the pound after the Brexit vote, the
only trend has been sideways," said Jordan Rochester, currency
strategist at Nomura Bank. "It's a big range for people who zoom in
on the screen like traders, but if you take a longer view, like the
1970s, it's gone nowhere."
Lawmakers' support for a Brexit deal for the first time on
Tuesday has further pared expectations of sterling-dollar
volatility over the next month because it signaled that the U.K.
may be able to avoid leaving the bloc without an agreement.
Banks' Borrowing Costs
Borrowing costs for U.K. banks such as Lloyds Banking Group PLC
climbed steeply at times when a disorderly exit from the EU seemed
most likely. Those spikes were partly triggered by large investors
offloading the lenders' bonds.
The credit outlook for the U.K.-focused banks was also clouded
for a time by their perceived exposure to the domestic economy, as
growth slowed because the Brexit uncertainty led businesses to
defer investment decisions or move operations elsewhere.
The so-called "Brexit premium" -- whereby increased uncertainty
led to higher borrowing costs for U.K. banks than it did for
European lenders such as Société Générale SA -- has diminished in
recent weeks as investors bet that a no-deal Brexit may be
avoided.
Economic Growth Stalls
By the fourth quarter of 2017, just over a year after the
referendum, economic growth in the U.K. had fallen behind that of
the lethargic eurozone. This was partly explained by a reluctance
among businesses to invest in operations amid the prolonged
political uncertainty.
"There is an incentive for anyone spending money to delay that
decision, whether that is spending money as a consumer or making an
investment in a business," Mr. Ellis said. More recently, both
economies have felt the pressure of a global slowdown and trade
tensions between the U.S. and its partners.
Stocks in a Slump
The U.K.'s main benchmark stock index, the FTSE 100, has failed
to match the bullish rally in U.S. or even European equities as
investors remain wary of the outlook for British businesses.
Smaller companies in the FTSE 350 benchmark are seen to be even
more vulnerable to the vagaries of the Brexit proceedings, because
of the impact of currency fluctuations on their operations and the
perceived risk of future trade friction with the EU.
There is a 20-25% gap in the valuations of companies that rely
on the U.K. for the majority of their revenue compared with those
with bigger international operations, said Simon French, chief
economist at merchant bank Panmure Gordon.
Only the finer details of a future trading relationship with the
EU will allow for a proper assessment of the outlook for the U.K.
and better pricing of its assets, according to economists and
analysts.
The range of possible outcomes has been narrowed as both the
best- and the worst-case scenarios have been avoided, according to
Kallum Pickering, senior economist at Berenberg Bank. In other
words, the chances of either leaving the EU without a deal or
remaining in the bloc have both fallen.
"If Brexit was a book, at the start it was impossible to guess
what the ending was," said Mr. Pickering. "Now the worst-case
scenario is ruled out, markets are less likely to be spooked by the
rest of the book. It's less likely to be a horror story."
--Caitlin Ostroff contributed to this article.
Write to Anna Isaac at anna.isaac@wsj.com
(END) Dow Jones Newswires
October 24, 2019 08:00 ET (12:00 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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