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Capital Ideas

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Categories
Brexit
3 reasons why the U.K. should be O.K.

It’s not worth dwelling too much on the reasons why British voters opted to leave the European Union. That question will be analyzed by political pundits and the media for years to come. For investors, a key question today is, will the U.K. be OK going forward?


While there will likely be ongoing political turmoil, market gyrations and potentially a recession in the months ahead, the long-term investment outlook for the United Kingdom remains bright for all of the reasons that existed well before the June 23 Brexit referendum, notes Capital Group portfolio manager David Riley.


“The U.K. is a highly developed, liberal, parliamentary democracy and it will remain so. It is pro-business, pro-trade, pro-immigration and, in my view, it is an attractive long-term market and base for investment," Riley says. "Moreover, London is one of the most vibrant, dynamic and international cities in Europe. None of that changes post-Brexit.”


With this sentiment in mind, here are three reasons why the U.K. should be OK:


1. The Bank of England


The U.K. has a powerful and independent central bank, much like the U.S. Federal Reserve, with the authority to drastically shift monetary policy when necessary. The BOE probably will cut interest rates soon in a bid to help support the British economy. The central bank could also launch a bond-buying stimulus program, similar to those in use previously at the Fed and currently at the European Central Bank.


2. The Pound Sterling


Since the U.K. many years ago decided not to adopt the euro, the pound sterling remains today as an influential global reserve currency. The value of the pound has fallen in recent days, but there is an upside to that development. A weaker pound could provide a boost to U.K. exports and tourism, especially heading into the summer vacation season. One reason Greece has struggled to recover from its economic downturn is that, as a member of the euro zone, it no longer has the ability to devalue its currency.


3. The London Office


London remains one of the most popular cities in the world for corporate headquarters and regional headquarters. Of the 250 largest companies in the world, 40% of them have chosen to base their headquarters or regional headquarters in London, according to the accounting firm Deloitte. Given the cost and complexity of relocations, that isn’t likely to change anytime soon, notes David, and the talk of mass corporate relocations is overdone.


The list of major companies headquartered in the U.K. includes HSBC, Royal Dutch Shell, BP, Barclays and GlaxoSmithKline, among many other prominent names. Other key business advantages of the U.K. include access to highly skilled workers, a competitive corporate tax structure, cutting-edge information technology infrastructure and a world-class transit system running through much of the country.


None of this negates the fact that leaving the European Union will almost certainly deliver a short-term economic shock to the U.K. economy. It could be particularly bad if the EU decides to make new trade negotiations with the U.K. difficult as a warning to others, says Thomas Hogh, a portfolio manager in Capital Group’s London office.


“The issue here is that the U.K. unilaterally has decided to leave the EU with the associated trade agreement for goods and services,” Hogh says. “Until we know what arrangement the U.K. can make with the EU after it has left, we can only guess what the outcome will be.”


Under the set of rules governing a departure from the EU, the exit process is expected to take  a maximum of two years. However, it could take longer, since a formal commencement requires a vote of Parliament, which hasn’t happened yet and may not happen for months. The process could easily extend into 2018 and beyond.


“Between now and then, there is a lot at stake for both the EU and the U.K. to arrive at a workable arrangement. The path to get there won’t be straightforward, but I believe a solution ultimately will be found," says political economist Talha Khan. "The U.K. may be in uncharted territory, and indeed faces a difficult economic adjustment ahead, but its institutions, rule of law, and attractiveness as a place to invest will likely persist in its eventual future state.”



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