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09 March 2021

Tariffs and the Markets

In an event that was somewhat overshadowed by the Coronavirus pandemic and the festive period, the Brexit deal marks a momentous occasion for UK and its future relationship with its largest trading partner, the EU. The gravity of such a deal cannot be overstated. Thought to be worth £668bn each year and covering almost every corner of the economy from fishing to healthcare, the deal helps to provide at least some clarity going forward for British and European companies who rely on each other to do business. The deal will mean lower import/export costs and a reduction in red tape than under a no deal or hard Brexit scenario, allowing firms to continue trading freely across borders and helping to secure jobs.
 
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Heralded by Boris Johnson as a significant win for the UK, with Brexit finally done and the economic cost minimised, he is likely to remain popular amongst Conservative peers. However, while the deal covers most areas of contention for the two economies, agreements on financial services remain limited and may weaken London’s globally recognised position as the financial hub of Europe.
 
Taking a more general market perspective, the deal is likely to benefit those companies most who retain significant operations in either the UK or the EU, and/or those who rely on either side for trade. Somewhat surprisingly, this excludes many in the FTSE 100 and is more likely to impact the more domestically-focused FTSE 250. The 100 largest UK listed companies derive 76% of their revenues from locations outside of the UK, with the US a popular export destination for global firms. Ashtead, a UK listed industrial equipment rental company, accounts North America (US and Canada) for 89% of its revenues and the UK for just 11%, exposing the company to exchange rate fluctuations between the Dollar and Pound rather than the completion/quality of a Brexit deal. More domestic-focused companies which reside in the FTSE 250, such as airliner easyJet, derive the majority of their revenues from both the UK and EU, while also maintaining strategic bases across Europe, are more likely to be impacted by the aerospace cooperation and will certainly be more relieved that an agreement has been finalised.
 

ONGOING NEGOTIATIONS

Since the industrial revolution, and more recently the mid-1900s, the UK has been slowly transitioning towards a services-based economy. Sectors such as legal, financial and consultancy have seen impressive growth at the expense of more traditional sectors such as manufacturing and agriculture. Given the current makeup of the UK economy and its reliance on services such as finance, it further underscores the need for clarity over the sector’s future relationship with the EU.
 
This means that further negotiations will be required if the UK wants to protect its services sector. However, pressure from businesses and industry groups will likely ramp up in the coming months after years of negotiations, only to be left out of the main deal almost entirely, may leave many short on patience.
 
However, given that the UK will continue to abide by GDPR regulations while also adopting other EU regulations, we can say that both parties do possess similar aspirations when it comes to outcomes. While small differences remain, it is clear that agreements on financial services and other areas of contention are in everyone’s interest with the main Brexit deal setting an encouraging precedent.
 

LONG-TERM IMPACTS

The policing of such a deal, however, may potentially create one of the most significant long-term impacts on markets going forward, particularly in the UK. If either side suspects the other is diverging from any part of the deal and gaining an unfair advantage, they each have the right to challenge the other through a dispute mechanism which could, in the worst-case scenario, end with tariffs being imposed on either side.
 
However, given that this is not an ideal outcome for either side, any legal challenge will likely be met with significant opposition and potentially a war of words. With financial markets disliking uncertainty in any form, investors will not look upon tariffs or such rhetoric favourably. With the UK particularly adamant that it would like to govern itself as it sees fit and the EU insistent that it sticks to (or at least close to) its rules, this could create a recipe for disaster that ends in tariffs.
 
We have seen under the Trump administration the effect that tariffs can have on global markets and consumers, creating problems for businesses across multiple regions and often helping to raise the price of goods and services. During the US-China trade war, the S&P 500 dropped almost 20% on concerns over the escalating tensions between the two countries and its impact on businesses. While a UK-EU trade dispute is unlikely to rise to this level, it serves as a warning as to the thoughts and fears of investors and the further disruption that companies may have to endure.

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Please note that investments and income arising from them can fall as well as rise in value. Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.
Tariffs and the Markets
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