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Brexit – what prospects for trade, financial services and foreign direct investment?

Rathbones’ asset allocation strategist, Ed Smith, outlines the investment house’s views on trade, financial services and foreign direct investment, the topics commonly focused on in its conversations with investors

Trade

We are not concerned about the imposition of tariffs in the event of a hard Brexit. The average weighted tariff that would be payable on the UK’s exports to the EU under World Trade Organisation rules would be a little over 3%. Clearly, that has been paid many times over by the 21% fall in the Euro to Sterling exchange rate since it peaked in August 2015.

We are much more concerned about non-tariff costs to trade (in Western markets dominated by complex regulatory and certification costs, quality assurance and labelling regimes, state subsidies and minimum import prices).

The academic literature is fairly unanimous that non-tariff costs are significantly larger than tariff costs. But this is a longer-term threat: given that the UK is already set up to comply with EU regulation, additional non-tariff costs in the short term would be broadly limited to more onerous burdens of proof.

Financial Services

This is our biggest concern. The ‘export’ of financial services is a significant contribution to the UK economy. The UK’s trade surplus in services is almost entirely in financial, and other professional and technical services often ancillary to finance.

Again, this is not a risk that would be realised overnight. We should not underestimate London’s history of financial innovation and predisposing government policy. However, if the UK failed to negotiate a bilateral agreement that enshrined the continued passporting of its financial services, it is difficult not to envisage a gradual loss of business and investment.

This would add to our already negative view for commercial property – central London vacancy rates have already edged above their long term averages.

Foreign direct investment (FDI)

Investment intentions had been on a downward trend since 2014. They have actually improved this year, but remain low and we do not expect business investment to make any meaningful contribution to UK growth while the cloud of Brexit hangs over UK commerce.

Research suggests the most important drivers of global FDI are market size and agglomeration – a fancy term to describe the benefits when firms and industry networks locate near one another.

A hard Brexit would clearly impact market size but other factors that compel agglomeration in the UK would remain.

Investment will not be immune, but again we would not envisage inward investment collapsing in the event of a hard Brexit. Surveys by EY tell us that R&D is ‘the business function that will attract the most investment in Europe in the coming years’.

We would like to see government incentives for R&D-based investment to improve the outlook for investment overall.

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