On Monday 19 March, the UK and the European Union (EU) announced a much anticipated transition agreement. The EU chief negotiator, Michel Barnier, dubbed the deal a “decisive step” on Britain’s road to leaving the EU in an orderly manner. The agreement paves the way for resolutions on many topics, but there are some unresolved issues, not least the Irish border. However, it is hoped the transition deal will help provide a foundation to build the final relationship between the UK and the EU, and avoid a cliff edge Brexit date.
The transition period will last from 29 March 2019 to 31 December 2020. During this period little is expected to change, with citizens and businesses effectively operating under the status quo. So the UK will therefore, for example, remain part of the Common Fisheries Policy until 2020, with no direct say on the rules. However, the UK will be able to negotiate, sign and ratify its own trade deals during the transition period.
Arguably, the most complex and sensitive issue is the Irish border. To prevent a hard border between the Republic of Ireland and Northern Ireland, a “back-stop” agreement has been made whereby Northern Ireland will remain part of the EU single market and customs union in the absence of alternative solutions. This effectively moves the border between the UK and the EU into the Irish Sea, which Theresa May has previously stated is unacceptable as a long-term solution.
It is clear that to get to this stage there has been compromise from both sides, but particularly from the UK, which has relented on cash payments for the divorce bill and is no longer challenging the status of EU citizens living (or arriving) in the UK during the transition period (the same rights have been guaranteed for British people living in the EU).
It is worth noting there are no specifics on whether the transition can be extended. This is likely to come up again towards the end of the transition period if negotiations are dragging on and could well be used as a tool to force a compromise as a hard deadline approaches.
Sterling has responded positively, and businesses will be glad to avoid a cliff edge next year. However, many firms will continue to make contingency plans as there is not much detail yet on exactly what the final trade agreement will look like, particularly for services.
The impact on the market has been limited (the FTSE All-Share fell abruptly on the day of announcement but so did most major markets). The deal should provide incremental certainty to businesses and sterling rising should help with imported inflation eating into wages. However, inflation had already been easing prior to the transition announcement (inflation fell to 2.7% in February, down from 3% the month before).
In summary, we see the transition agreement as a positive for the UK economy and an indication that negotiations are going to be characterised by compromise from the UK. From a market perspective, the deal is incrementally positive for UK domestic stocks.
The UK market is unloved and under-owned, and is trading at a discount to historical levels, yet it is also delivering 6%-7% earnings growth with positive earnings momentum. Hopefully this transition arrangement will help ease the “too hard to own” thinking that some may have on the UK.
Callum Abbot is the portfolio manager of the JPM UK Equity Plus Fund. Read more >
Unless otherwise stated, all data is sourced from Bloomberg as at 21 March 2018.
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