'Brexit Fog To Clear': Fund Managers Increase Exposure To 'hammered' UK Financials Sector

Although it was expected the Bank of England (BoE) would follow the Federal Reserve's path in hiking rates this year, growing concerns around the Brexit negotiations prompted analysts to rein in rate rise expectations causing a "knock-out" blow to the UK financial services sector in 2018.

Last year, the FTSE All-Share Financial index plummeted 13.6%, underperforming both the FTSE All-Share and MSCI World, which lost 9.5% and 3% respectively.

Higher interest rates, an environment typically supportive of banks, have been put on hold by the BoE, having only been raised twice since the cut in August 2016; the BoE stated in its last Monetary Policy Committee meeting that "key parts of the EU withdrawal process have remained unresolved and uncertainty has intensified".

Markets are pricing in just a 35% chance of a hike this year after UK GDP growth was reported at the lowest in six years in 2018, and the UK Consumer Price Index (CPI) dropped below the BoE's 2% inflation target to 1.8% in January.

However, Jamie Clark, co-manager of the Liontrust Macro Equity Income fund, is predicting the BoE will return to a hiking path and raise rates twice later this year amid more clarity around Brexit, which in turn would be the catalyst for a rally in the financial sector.

With the UK unemployment rate at its lowest since 1975 at 4%, and year-on-year pay growth above 3%, Clark said the only issue for the "institutionally dovish" BoE remained Brexit.

"Since the Referendum [in June 2016], everything has been about Brexit for the BoE," he said. "When the fog of Brexit clears, this will remove the reason for their caution."

"Brexit has been the major overhang for UK rates and therefore companies related to rates.

"Financials have been hammered post-Brexit vote and are trading on knock-out ratings," he continued. "It is no surprise because they are geared to the UK economic cycle and to the path of UK rates."

On the issue of Brexit, Clark, who has 33% in financials including positions in Lloyds and Legal & General, said fears were overdone.

He referenced the BoE's Brexit stress test last November, which predicted UK GDP could fall by as much as 8% in the event of a no-deal, a more damaging recession than the 2008 Global Financial Crisis.

Furthermore, it warned interest rates would rise in this scenario to combat an increase in inflation to 6.5%, while house prices could fall by 30%.

At the same time however, the BoE found all seven major UK banks had passed its stress test results, with the Financial Policy Committee (FPC) claiming the "UK banking system is strong enough to continue to serve UK households and businesses even in the event of a disorderly Brexit".