With just weeks to go before the U.K. is due to leave the EU, time is running out for the British government to thrash out a Brexit withdrawal deal that suits all parties.
Many predict that an extension to Article 50 will be granted to give politicians enough time to come to an agreement. Recent appreciation in the British pound suggests investors are hopeful that this will be the case, even though EU leaders have warned that they aren’t open to further negotiation.
The International Monetary Fund (IMF) certainly appears to be worried. On Monday, the Washington-based lender laid out another warning, cautioning that a no-deal scenario could knock between five and eight percentage points off Britain’s gross domestic product and threaten the global economy.
Hit to Corporate Profits
Economists often cite trading hurdles as one of the biggest risks of a no-deal Brexit. If the U.K. leaves without an arrangement with the EU in place, trade will suddenly switch to World Trade Organization terms, raising tariffs and customs checks overnight.
Tariffs and restrictions on exports of goods and services have several negative side effects. Costlier imports, on top of a predicted depreciation of the country’s currency, will inevitably increase prices and see inflation rise substantially. Such a scenario would inevitably weigh on corporate profits, squeeze consumer spending power and potentially destroy the British economy. If that happens, the rest of the world, and the many international companies that do business with the U.K., are unlikely to emerge unscathed.
Then there are the excise duties on goods coming into the U.K. The Economist warned that a no-deal Brexit would create uncertainty over certifications and standards of products, adding that food supplies would be at risk to the point where rationing might need to be introduced. The supply of medicines and medical devices could also grind to a halt.
Financial Contracts In Question
Other concerns that were flagged include a shortage of labor if EU citizens are no longer able to live in the U.K. and London’s status as a global financial center. Banks and financial-services firms operating out of the nation’s capital, such as Barclays Plc (BCS), have been moving into Europe out of fear that a no-deal Brexit could strip them of their ability to serve clients in any EU country from Britain.
The status of financial contracts is under threat, too. As things stand, a no deal Brexit would mean that clearing in London would no longer be available for clients in the EU.
The Economist also warned that a no-deal Brexit risks upsetting air travel and electricity and triggering a rise in international fugitives.
Impact on ETFs
Given how much is at stake, investors will be keeping close tabs on U.K. exchange-traded funds for buying and selling opportunities. They include the iShares MSCI United Kingdom ETF (EWU), which primarily tracks large- and mid-cap British companies, small companies fund the iShares MSCI United Kingdom Small-Cap ETF (EWUS) and the Invesco CurrencyShares British Pound Sterling Trust (FXB).
Goldman Sachs has assigned a 10% probability to a no-deal Brexit and expects "modest near-term upside" for U.K. stocks if the risk of such a scenario fades. It has also said the pound should strengthen relative to the U.S. dollar if a Brexit deal is reached.
The pound has been particularly volatile during Brexit negotiations. It currently sits at around $1.30 and traders are betting that it could fall below $1.20 in the event of no-deal, according to The Economist.