Tuesday 16 January 2018

British property and sterling could be biggest casualties of Brexit


A broker looks a graph depicting the change in sterling on the trading floor at ETX Capital in London. The pound could face further issues as Brexit bites. Photo: Jason Alden/Bloomberg
A broker looks a graph depicting the change in sterling on the trading floor at ETX Capital in London. The pound could face further issues as Brexit bites. Photo: Jason Alden/Bloomberg

Brian O'Reilly.

If there is one thing investors do not like, it is uncertainty - and Brexit clearly makes the investment landscape more unpredictable. Will there be a hard Brexit? How will trade between the United Kingdom and Ireland be impacted? What will happen to property prices and sterling? These are just some of the questions that are top of investors' minds.

For sure, Brexit makes the UK a less attractive destination for global investors. The reality is we won't know the answer to many of these questions until Brexit negotiations are concluded. This could take more than two years.

In the interim, the reality facing the minority Conservative government is that the economy is weakening. It's true the immediate shock from the Brexit referendum was not as bad as expected, but most economic indicators have been moving down since the start of the year. Consumer and business confidence is being negatively impacted, inflation is rising, property prices are falling, and all this is taking its toll on UK consumers. This puts a number of investments at risk - and I highlight sterling and British property as potentially being two of the biggest casualties from the Brexit fallout.

The decision to vote for Brexit sent shock waves through currency markets, and evoked dark memories of previous sterling crises.

On the day of the recent hung parliament election result, the pound hovered just above its lowest level against the dollar since before the Plaza Accord was signed in 1985. However, just because sterling has fallen doesn't necessarily mean sterling is cheap.

We shouldn't expect sterling to recover anytime soon. The UK's budget and current account deficits are high. History has shown that currencies of nations with twin deficits can be prone to bouts of weakness and, in a worst case scenario, the pound is not immune to speculative attacks similar to the Exchange Rate Mechanism (ERM) crisis in 1992. This makes buying sterling assets particularly difficult for foreign investors.

Since the financial crisis, house prices have risen by close to 40pc across the UK - but have almost doubled in London. This has pushed the average London house price to £480,000, compared to just over £200,000 for the country as a whole.

The net result is that property gains have far outstripped individual's income and priced many out of the market; pushing affordability to historical highs. The house price-to-income ratio for first-time buyers in London is at 10.1 times the average income, which is in stark contrast to the average price-to-earnings ratio of 5.3 times in the UK.

However, there are clear signs that the UK property market is coming under pressure. House prices in the UK fell for two consecutive months in March and April of this year - the first time this has happened in nearly five years. Many businesses are already making plans to move workers overseas which will leave vacant office space.

Increased job insecurity, particularly among those working in financial services in the City of London, has reduced activity in the residential property market.

Prime real estate in London has already fallen by about 13pc off its mid-2014 peak, according to Savills. Estate agents are offering cars, iPads and sound systems to entice buyers, according to a recent article in The Guardian. These are worrying signals that London's property bubble is deflating - and there could be more to come.

Brian O'Reilly leads the Global Investment Strategy team at Davy Private Clients. See davy.ie.

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