Finding—and supporting—a precise cost of capital for UK valuations presents many challenges, but a thoughtful analyses by Reuters at least provides some context. In short, the FTSE lags STOXX by 17%, the pound is more volatile than the euro thanks to the treaty-defying Brexit vote and other factors, and the risk-free rate is more than 20 basis points higher for bank lending compared to the EU.

In other words, the UK’s cost of capital is higher than its neighbours. The Brexit premium is real and may be increasing.

Other risk factors that impact UK business valuations highlighted by Reuters:

• Sterling-implied volatility. Implied volatility (options that show investor expectations of future price swings in a currency) is at five-month highs, at around 12%—'well above implied vol on other G7 currencies.’
• Equity risk. British stocks have underperformed since June 2016, and, as of last week, the FTSE is 17% behind STOXX for the year. Brexit is one reason, but the FTSE reliance on weak sectors is a structural problem.
• The Brexit premium is real. Reuters quotes Justin Onuekwusi, who says, ‘If you look at sector differentials—for instance UK energy or financials versus the rest of the world, you can see an additional risk premium on the UK.’ Onuekwusi is a portfolio manager at Legal & General Investment Management.
• Bank borrowing is more expensive for British companies. ‘For instance, the gap between the yield on Barclays’s September 2023 euro-denominated bond and a Deutsche Bank note maturing the same month has widened of late to the highest in nearly three months around 38 basis points.’ This situation is worsening currently—Reuters quotes ABN Amro analysts who found that spreads on euro-denominated bank bonds widened around three basis points last week—but UK lenders saw spreads worsen by 20 to 30 basis points.
• More money managers expect negative UK interest rates. ‘Money markets have brought forward bets of a Bank of England rate cut, pricing negative interest rates for early-2021,’ the study says. The UK curve is steeper compared to the Bund curve.
• Market-based measures are betting on higher UK inflation. This trend also appeared after the 2016 referendum when the pound crash lifted inflation expectations.