Now, while it is possible to make a case about the pandemic causing more economic damage to the UK than Europe, the Brexit factor can certainly not be disregarded. The European Union (EU) accounts for 43% of all UK exports and 51% of all UK imports[3]. The UK’s share in EU’s trade is not insignificant but is certainly smaller with the UK accounting for 14.9% of all EU exports and 10% of all EU imports[4]. UK falling out of the trade union without a conducive trade deal will put UK exports at a competitive disadvantage and sting the UK much more than the EU.
The silver lining may be short-lived
The FTSE 100 Index made gains of nearly 15% between 23 June 2016 Brexit referendum day and the end of 2016. This was not because markets perceived Brexit to bring significant economic benefits to the UK economy. Instead, it was triggered by a drastic fall in sterling – a sign that economic prospects had sharply deteriorated. Given FTSE 100 companies generate more than 70% of their revenue from abroad, sterling depreciation boosted the competitiveness of UK exports in the short term and hence, lifted UK equities.
A similar effect could provide a silver lining now with sterling likely to get weaker as the Brexit conundrum becomes more vexatious. The Bank of England’s recent indication that it is amenable to considering negative interest rates may also hold the currency from gaining strength. This short-term respite must not, however, mask UK’s Brexit challenge even if equity markets end up taking a myopic view. Investors could therefore consider continue to seek defensive hedges to not only mitigate the risk of a disorderly and disruptive Brexit, but also the uncertainty leading up to it.