What does a no-deal Brexit mean for interest rates and dividends?

 A City bank gives its verdict – and says WTO terms will have a limited impact on the UK equity market.

A City bank whose backing for UK assets is undiminished by a no-deal Brexit scenario has given its verdict on the prospects for negative interest rates and dividend growth in 2021.

The analysis by the wealth management team at UBS covers five key questions for the year ahead, concluding that the UK should outperform regardless of the Brexit outcome.

The report said:

“The UK is currently our most preferred equity region, benefiting from a relatively high exposure to stocks and sectors that have so far lagged the recovery. Even in a no-deal Brexit scenario, we expect UK stocks to perform well.”

UBS praised the “quick, decisive and effective” response of the Bank of England to the pandemic and questioned whether going further on interest rates would have an impact, particularly if it prompts commercial banks to reduce their lending books to protect balance sheets.

The report added: “Returning the economy back to pre-crisis levels of GDP is not a problem that monetary policy alone can fix; rather, the solution lies in the hands of HM Treasury.”

In fact, UBS doesn't think the Bank will cut rates immediately in the event of a no-deal, as such a move would be outweighed by the supply-side disruption. Avoiding negative interest rates should allow the recent outperformance of financial stocks and aid the recovery of sterling.

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Overall, the bank thinks that the UK economy and its level of earnings are unlikely to return to pre-pandemic levels before the end of 2022, partly because the country was one of the hardest hit economies in the first place due to a reliance on services. Some sectors like energy have also seen significant profit declines, which will take longer to recoup due to lower oil prices.

That said, the bank expects overall growth to pick up materially from the second quarter of 2021 and maintain a healthy pace in 2022. Its base case is for the FTSE 100 to be at 7,000 by the middle of 2021 and 7,100 by next December, which compares with 7,542 before the pandemic.

The UK market currently trades at a 26% discount to global equities on a forward price/earnings basis, but some of this gap should close regardless of Brexit events as financials, energy stocks and other cyclical sectors continue to recover and EU relations stabilise.

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The first half of 2020 saw nearly half of FTSE 100 companies cut their dividend, but UBS notes an upside risk to the City's current consensus for UK dividends to grow 17% in 2021.

Some cyclical companies, like homebuilders, have already reinstated their dividends, while banks are likely to do the same once the current regulatory ban runs out this year. The current dividend yield in the UK is 4%, which UBS said remained an attractive income stream in an environment of low interest rates.

The fifth point considered by UBS in its review of the UK's 2021 outlook concerns Joe Biden and the prospects for a UK/US trade deal once the President-elect arrives in the White House.

The UK will be in more of a hurry for an agreement, given that the US accounts for 20% of exports of goods and services. And while UBS is not expecting rapid progress on any deal, it thinks it will have a relatively limited impact on the UK equity market overall.