While equities are adjusting to the latest failed negotiation, we do not think the market is really prepared for what could happen on Sunday and how it will impact the market on Monday. Depending on how the UK and EU frame a failed trade agreement Sunday, UK equities could be down as much as 5-7% on Monday in severe risk-off scenario with banks, industrials and FTSE 250 leading the declines. This is our best guess in a very bad scenario as we have no statistics to rely on making this event about uncertainty in the word’s true meaning. Investors could hedge their portfolio through CFDs, futures or options depending on what fits the portfolio and objectives best, but we urge investors with a lot of UK equity exposure to consider the risk picture going into the weekend.
A logistical mess on January 1, an economic shock, and a new city of London
If a trade agreement is not reached, then a logistical nightmare will happen on 1 January as the EU and UK will fall back into rules and tariffs established by WTO in 1995. This means that the UK will have to start paying tariffs on imports from the EU, and vice versa. The UK consumer can expect a rise in prices on grocery with 85% of the food imported from the EU will at least get a 5% tariffs rate. UK carmakers would experience a 10% tariffs rate and being the biggest export category of the UK economy, this will have a significant impact on the export economy. The services sector will likely have to set up local offices in Europe to service clients. In terms of energy infrastructure, the UK would also be cut off from the EU energy market. Allianz estimates that the UK could experience an overall increase in import prices of 15%, a 10% depreciation of the GBP, increased supply chain and administrative costs, on top of a 5% drop in GDP and 15% drop in total exports.
UK export composition in 2018 (chart below)