London The Corona crisis has one good thing from the perspective of many Britons: it has pushed Brexit off the agenda. Since the UK left the EU in late January, the issue has become quiet. The future trade relationship with the EU is not yet regulated, and the “no deal” threatens again at the end of the year.
A further drop in the pound is therefore expected in the coming weeks. Three factors put pressure on the British currency. In addition to Brexit, these are above all the continued corona lockdown in Great Britain and a newly sparked debate about negative interest rates from the Bank of England.
The next deadline for investors is the end of June. In the meantime, British Prime Minister Boris Johnson would have to apply in Brussels to extend the transition period beyond 2020.
If he does not do so as announced, the British currency could drop another ten percent to $ 1.08 in the next six months, DZ Bank analysts estimate. By the end of the year, “even more extreme movements” would be possible if no agreement was reached.
After the corona crisis, the kingdom can afford an unregulated Brexit even less than last year, the analysts write. “Britain has more to lose.” Failure of the free trade talks would plunge the UK economy into recession in early 2021. The pound would depreciate significantly and imports would become more expensive, which in turn would hit the British purchasing power and willingness to consume hard. Overall, the economy would grow 5.5 percent less in this scenario than with an EU free trade agreement.
The bank’s experts, on the other hand, would have a much smaller effect on the EU. In the event of a chaos Brexit, growth would only be 0.5 percent lower here because many companies had already reorganized their trading relationships with Great Britain.
The “no deal” remains a pure risk scenario, the authors emphasize. DZ Bank continues to believe that a “face-saving solution” will be found. For example, the British and Europeans could agree on a framework agreement by the end of the year, which in turn would require an implementation phase. This would amount to an extension of the transition period.
The third round of negotiations in Brussels ended unsuccessfully last week. This reminded investors that there is no real progress, the analysts of the British bank Barclays write. The pound will therefore drop significantly below $ 1.20 by the end of June.
As early as May, the pound was the weakest currency in the “G10” circle, as the ten most traded currencies in the world are called. “This suggests that something special is happening here,” said Kamal Sharma, a strategist at Bank of America. “The special thing is Brexit.”
The experience of the Brexit process teaches that the ultimatums of the two negotiating partners need not be taken too seriously, says Sharma. But the likelihood that the UK government will extend the transition period is diminishing. He therefore also expects the pound to break down from its current range of $ 1.22 to $ 1.26.
2. Negative interest
There is also speculation that the Bank of England may soon introduce negative interest rates to boost the economy. Such a move could further weaken the pound. Central bank chief Andrew Bailey fueled the debate on Wednesday. Negative interest rates would be “actively checked,” he told the House of Commons finance committee. This was interpreted by some observers as a change of course because Bailey downplayed the possibility of negative interest rates last week.
It would be the first time in its 325-year history that the Bank of England has cut interest rates below zero. It is currently 0.1 percent. The debate was fueled on Wednesday because for the first time, the yield on a multi-year government bond fell below zero, namely to minus 0.003 percent. So investors seem to be one step ahead of the central bank.
Experts believe negative interest rates in the UK are a mistake. Switzerland or the euro zone could afford it because they have a current account surplus, says Sharma of Bank of America. Britain, on the other hand, has a large current account deficit. “If you introduce negative interest rates, who will finance your deficit? Nobody.”
Kit Juckes, macro strategist at the major French bank Société Générale, also strongly advises against this step. He couldn’t imagine an economy where negative interest rates would be worse than in Britain, he said. The economic benefit is questionable. However, it is very clear that a cocktail of negative interest rates and massive bond purchases would weaken the currency.
Investors expect the rate to drop below zero in December at the earliest. This is indicated by the interest rate swaps, which reflect the market expectations for the future. Bailey also did not give the impression that the taboo was imminent. First you want to see how the previous instruments work, said the central bank chief.
The Bank of England had expanded its bond purchase program by £ 200 billion to £ 645 billion in March. It also offers banks and large companies the opportunity to finance themselves at low interest rates. On top of that, it provides the government with unlimited funds to fund the fight against the recession.
According to Barclays, negative interest rates are the very last means the central bank will use. First, at the next meeting of the Monetary Policy Committee in June, she will add another £ 100 billion to the bond purchase program. The investment bank RBC Capital Markets even expects an expansion of £ 200 billion.
If all of this does not mitigate the economic downturn, the central bank could be forced to take another rate hike in the second half of the year. The decline in the inflation rate also increases the pressure. It fell to 0.8 percent in April – well below the long-term target of two percent.
However, Bailey does not yet seem convinced of the benefits of a rate cut. He indicated that their economic impact would weaken, the lower the interest rate was. The experiences of other central banks with negative interest rates are “mixed”. They could also be counterproductive because they weakened the banking sector.
3. Corona shock
Another reason for the weakness of the pound is the general economic uncertainty. In the corona crisis, investors seek refuge in safe havens. First of all, this is the dollar, to a lesser extent the euro, and certainly not the pound. On the contrary: The financial news service Bloomberg already described Sterling as the “pari currency”, with which investors do not want to have anything to do.
The pandemic has hit Britain harder than other countries. The kingdom has the most deaths in Europe. Therefore, the government is loosening the exit restrictions very slowly, which deepens the recession. The Bank of England expects economic output to plunge 14 percent this year. The recovery is not expected to take a V-shape, but will last until 2022, deputy central bank governor Ben Broadbent said on Wednesday.
Finance Minister Rishi Sunak also sounds less optimistic. The recession will be “harder than anything we’ve experienced,” he said. It was “not obvious” that the economy would quickly recover from the shock. “It takes time for people to get back to their old habits.”
In the first corona shock, the pound had temporarily dropped to a 35-year low of $ 1.14 on March 18. It could test this low again in the course of the year. The corona uncertainty coupled with the Brexit concerns would result in an unfavorable mix, says Sharma.
More: Britain’s inflation rate has dropped to its lowest level since 2016.