A ‘no deal’ on Brexit and a possible Bank of England interest rate hike are two key issues investors should not rule out in 2018, according to The Share Centre’s Richard Stone. 
Investors in the UK market face a lot of uncertainty in the coming 12 months with Brexit negotiations likely to take centre stage, though nobody knows what affect this will have on the market.
Indeed, Andy Merricks, head of investments at Skerritts Wealth Management, told FE Trustnet earlier this month he has sold out of his exposure to the domestic market due to its unpredictability.
“We pretty much came out of the UK once the referendum result had been called because no one knows what Brexit means – politicians don’t, economists don’t, no one does,” he said.
However, despite the ongoing uncertainty, the FTSE All Share has returned 43.45 per cent over the last two years, as the below chart shows.
Performance of index over 2yrs
Source: FE Analytics
This is partly due to the strength in the global economy which has helped boost some of the UK’s largest exporters. Additionally, the UK economy has held up better than expected, despite a fall in sterling, thanks to strong consumer demand.
This year, however, the economy appears to be on a knife-edge, according to Stone, and one thing that could tip the balance is how Brexit negotiations are progressing.
“Political instability has to be [a big theme] for this year in a number of different guises,” Stone said.
“If you look at the UK you have the Brexit negotiations and they are going to be a rollercoaster through the course of 2018.”
He said the British negotiators need to have agreed a deal by the end of October so it can go through the various European parliament processes as well as the UK Houses of Parliament.
“I think that is going to be tight,” he explained.
However, there remains a serious risk of a ‘no deal’ as any potential contract has to be passed by 27 European parliaments.
“The press are understating that the risk of a no deal is greatest in my view because of the continent rather than the UK,” said Stone.
“You only have to have one or two governments play awkward and the whole thing could fall apart because there is a lack of consensus on the other side.
“It is difficult to negotiate with one person who has been given a mandate but the decision-makers are sitting behind them. It is potentially fraught.”
As well as this, he said there is the potential – albeit not a particularly high one – that another general election takes place should there be issues getting a bill through parliament.
“There is even the risk that the UK government fails and we end up with another general election in 2018, as it is pretty fragile,” Stone noted.
“The general sense of direction at the moment means that that could create quite a dramatic shift in the market if we ended up with an uncertain outcome.”
The other thing investors need to be aware of in 2018 is the potential for an interest rate rise from the Bank of England if inflation does not come down as fast as many expect.
In January, the Office for National Statistics announced that the consumer prices index (CPI) rate falling fell to 3 per cent in November from 3.1 per cent in December.
Source: Office for National Statistics
Ian Kernohan, economist at Royal London Asset Management, said: “Much of the recent rise in inflation was driven by sterling's devaluation during 2016.
“However, this factor will begin to fade and inflation should fall back towards the 2 per cent target over the coming year.”
While a decline in inflation is widely anticipated by forecasts, Stone warned that inflation could remain stubbornly high.
“Policy makers will be keen to see whether November marked a peak with inflation now starting to fall or whether it continues to remain stubbornly within this range,” he said.
“Much will depend on what happens to wages and inflation expectations – the concern being that higher inflation becomes baked into the system through higher wages. Evidence of such a shift would likely lead policymakers to increase interest rates more quickly.”
He added: “I think you will see another increase in the rates from the Bank of England because inflation will be slower to come back down than people expect and you are going to start see some of that inflation get turned into pay rises.”
Data from the Bank of England in recent months has shown that consumer expectations of inflation are at relatively high levels compared with recent years and this should also drive people’s demands for wage increases, which has been supported by a tight labour market.
Indeed, unemployment has remained low in the UK as companies have looked to improve productivity with new hires rather than investing in new technology. But as the supply of new labour falls this could also prove to be a catalyst for rising wages.
While inflation has fallen back more recently – albeit at above-target levels – Bank of England rate setters could get nervous, Stone said.
The chief executive said a “compelling economic argument” could be made that, in the short term, raising interest rates from a very low base could be inflationary as savers will see better returns on savings and encourage them to spend more.
Following the small interest rate rise in November, higher borrowing rates could also force some companies out of business who otherwise might have survived in a low rate environment, he said.
Some ‘zombie companies’ – those that are kept afloat by debt – could go bust, he said, meaning that supply of certain goods could tighten and, therefore, raise prices.
The final reason inflation may stay higher than expected is that oil prices have strengthened in recent months and this is likely to feed through into inflation in due course.
While the Brent crude index is only up 8.41 per cent in sterling terms over the last 12 months it is up 44.07 per cent since its 2017-low in June.
Performance of index over 1yr
Source: FE Analytics
“In the short term this has been partially offset by sterling’s strength against the dollar – recovering much of the fall it experienced following the Brexit vote,” Stone noted.
“Any weakness in sterling again would exacerbate the impact of higher fuel prices and could drive inflation higher – or at least mean it remains stubbornly at current levels.
“So, I think you have a number of factors there that might encourage at least one interest rate rise over the course of this next year,” he said.