This is the year that should see the shape of Britain’s future relationship with the European Union emerge, with inevitable consequences for everyone’s personal finances.
The stock market, inflation and interest rates could all be affected by the character of any agreement and by the twists and turns in the negotiation process.
Telegraph Money will resist the temptation to gaze into its crystal ball, aware of the future’s habit of refusing to conform to predictions, but will attempt to make clear the relationships between the various economic forces involved so that readers can at least be better prepared for the unexpected.
The stock market
Investors are now familiar with what happened to share prices after the EU vote, and why. The markets initially fell in panic, but soon realised that the sharp decline in sterling that followed the referendum boosted the profits of firms that make most of their money abroad – as many FTSE 100 firms do.
Hence shares in international firms rose. This has given rise to a strangely split market: overseas-focused stocks have continued to do well, but their performance has diverged markedly from that of domestically focused firms, whose shares have languished (see chart).
The stock market seems to be expecting a “hard Brexit” that results in the British economy suffering badly. So a different outcome could see the gap between international and domestic stocks diminish. The Telegraph’s Questor share-tipping column recently picked Sainsbury’s as well placed to gain in such an event. Others include Next and ITV.
Funds investing in this type of stock include Jupiter UK Income and Standard Life Equity Income investment trust.
Sterling’s gradual recovery since post-referendum lows suggests a sense of relief that the economy has not so far suffered in the way many predicted and that the Brexit negotiations have made progress.
The foreign exchange market’s relative calm probably reflects a belief that a highly damaging exit will be avoided. (It is not uncommon for different parts of the financial markets to signal different expectations about the same event.)
Part of the reason for sterling’s severe fall after the vote was the sense of shock at an outcome few predicted. It is hard to imagine a second shock of equal magnitude, even in the event of “no deal”, so were that to be the outcome a more modest decline seems likely.
A second fall could be expected to boost the shares of firms whose earnings largely come from abroad; the opposite would apply to domestically focused firms.
What happens to inflation largely depends on the fate of sterling. In the absence of further significant changes in the value of the pound, inflation should start to fall. If, on the other hand, a hard Brexit causes another slide in sterling, inflation can be expected to remain high, or to fall back and then climb again, given the time lags involved.
The Bank of England will be desperate to avoid a significant rise in interest rates, given the likely effect on overborrowed consumers. Even if a severe unravelling of the Brexit process led, via a fall in sterling, to a rise in inflation the Bank would probably overlook it.
The one thing that could prompt the Bank to raise rates significantly would be a severe run on the pound. The election of a Labour government under Jeremy Corbyn could cause this, given the markets’ distrust of his policies.
The Corbyn effect
Mr Corbyn in Downing Street could arguably bring about more extreme reactions in the markets than any Brexit outcome, given that investors are already to some degree braced for the latter cause of uncertainty.
We could expect a Labour victory to hit the pound, leading to a rise in inflation later. The stock market would probably fall initially, but any decline in sterling should support the shares of internationally exposed companies, as before. The opposite could be expected for domestically focused firms.
Any company exposed to the risk of nationalisation would fare particularly badly. Such firms include the utilities, rail and bus operators and Royal Mail.