Post-Brexit and the UK economy: How will the pound fare in a covid vaccine world?

  • A Brexit deal was finally agreed upon on Christmas Eve.
  • The pound is hesitating to move higher on Brexit latest news and we look at why it may not do so for the foreseeable future.
  • Coronavirus has hamstrung UK growth and economic recovery prospects, buoying EUR/GBP.

The announcements of a deal from both sides of the Brexit debacle came out over the course of the New York session on Christmas Eve.

The deal dismissed a cliff-edge scenario, preventing goods being stuck in queues at the borders. However, services agreements were kept limited largely to a non-discrimination clause.

Nevertheless, the pound was predicted to rally by several analysts. 

However, cable melted on the news and away from the 1.3620's and 2020 highs. EUR/GBP moved up and added some 1.4% between Christmas Eve and December 28th business.

Indeed, the deal was already in the price, but it is far from perfect, especially for financial services, which are a vital part of the UK economy.

All in all, this deal is more focused on goods sectors that make up a much smaller proportion of the UK’s economy than services. This is, perhaps, another reason why sterling was not celebrating the deal. 

Nonetheless, there is no going back now. Instead, the Association for Financial Markets in Europe (AFME) said they believed a deal on goods will lay the groundwork for future equivalence and further negotiations on financial services.

“We hope that this lays the foundation for further cooperation on financial services,” the trade group said on Christmas Eve.

“It is important that the EU and the UK now urgently put in place outstanding equivalence decisions to mitigate disruption at the end of the transition period and ensure a smooth adaptation to the new relationship,” the AFME added.

Holiday season markets reacting to Brexit news

Real money flows and speculative interest are set to come back to the market over the course of the final days of the year leading up to the December 30th vote, a formality, and the first weeks of 2021, once the dust has settled. 

The market's reaction to the deal will most probably play out over time as money managers, businesses and speculators gradually position depending on the pulse of sentiment.

However, the latest lockdown measures to be announced are a firm bearish playbook for sterling that lost a firm 1.18% on Monday 4th.

What now for the pound and economy following the Brexit deal? 

While the changing nature of the UK’s trading relationship with the EU and the rest of the world from January 1st, 2021 is one thing, the fate of the British pound comes down to many variants. These include COVID's impact on the UK economy as well.

There is a high risk that both the economic impacts of the coronavirus and Brexit are likely to affect the UK like never before, ultimately forcing changes in society and social behaviours. 

An increase in regional disparities will likely impact particular groups such as blue-collar workers highly concentrated in some of the “left-behind areas”, impacted the hardest by the lockdowns. These will include the Northern regions, South Wales and the West Midlands.

The effect on different sectors will cumulatively have a wider effect on the economy overall.

First and foremost, the UK’s deal with the EU will not be the smooth transition that many had hoped for.

In the longer term, the UK will diverge from the EU on things such as product standards or other regulations.

While the Covid-19 crisis will have profound structural effects on the UK economy, the labour market will be a particular focus in 2021, particularly for the pound.

And while it is likely that regions and sectors most affected by the economic impact of Covid-19 are not the same as the regions and sectors likely to be most exposed to Brexit, the combination will have a broader impact on the UK than either one of the crises would have done alone.

The covid crisis continues to speed up existing trends such as the move to more online shopping and more people are working from home. 

If we concentrate on Brexit, it is the manufacture of automotive, transport equipment, chemicals and textiles, and services such as finance and communications that are the most exposed sectors.

Whereas, with covid, tourism, entertainment, arts and hospitality will be the most affected.

The nature of both crises will undoubtedly lead to a long and protracted restructuring of the UK economy as well as social inertia and the impact of which will be felt for many years to come.

The North West, London, South East and the West Midlands may experience a ‘double whammy’ of both the economic impact of Brexit and Covid-19.  

As a whole, the economic impact of the pandemic has hit the UK particularly hard in comparison to other nations around the world and the latest variant of the virus is hugely damaging for near-term recovery prospects.

Facts, figures and projections following Brexit deal

The UK Gross Domestic Product followed a whopping 20% drop in growth for the second quarter of 2020 (twice as bad as the OECD average), with modest growth that limited the recovery to around 10% below its pre-covid levels, more than double the decline as seen in the US and the EU. 

Moreover, the latest GDP figures showed that the UK remained in a slow down even before the latest lockdown measures were announced. 

The pace of growth month on month is concerning, falling to just 1.1% into September following a decline from 9.1% in June, 6.4% in July and 2.1% in August. 

When you then add the latest labour market data, it shows that the redundancies have hit an all-time high.

Then, combined with around 10% of the workforce, or some 2 million that were either on partial or full furlough throughout July-Sep, it does not bode well for the start of next year.  

Unemployment increased to the highest on record in the three months to October, 4.9%, as many parts of the nation went into lockdown to combat the spread of the virus. A record number of redundancies, 370,000, came mostly from businesses such as shops, bars, travel and entertainment companies. 

If it had not been for the five-month extension of the furlough scheme, the unemployment rate would have soared even further this winter. This begs the question as to how high unemployment can go next year.

UK unemployment is likely to reach 2.6 million in the middle of 2021, according to the government's economic watchdog. That is 7.5% of the working-age population. The Bank of England made a similar prediction, with the Unemployment Rate peaking at 7.7% in April to June of next year.

As a result of Brexit and Covid-19, however, the Institute for Fiscal Studies expects unemployment to peak at 8-8.5% in Q2 2021.  

Moreover, the BoE admits that unemployment next year is very hard to predict, saying there's a small chance it could rise as high as 10%. 

However, those forecasts don't take into account the government's decision to extend the furlough scheme to the end of March.

With all that being said, December saw the start of a vaccination program that is aimed at bringing the Covid pandemic to an end. That would enable many businesses to start reopening and allow millions to go back to work.

First and foremost, the National Health Service must be fortified as a priority and after some initial delays to the program, it started to get jabs into the arms of workers in the health service. 

This is the first step of an arduous journey ahead to rid the UK population of the virus.

Meanwhile, the practical and procedural changes of Brexit will make for plenty of disruption for businesses.

Following the announcement of the deal, the SNP said it was "the understatement of the century" that the UK would face disruption, adding that millions of businesses would now face "a mountain of extra costs, red tape, bureaucracy and barriers to trade in just four days".  

Conservative grandee Lord Heseltine has urged MPs and peers to abstain when voting on the deal, warning it will inflict "lasting damage" on the UK.

The former deputy prime minister said he would "in no way share the endorsement of the legislation", but that he would not vote against it because the consequences of a no-deal would be even graver.

All in all, when it comes down to the value of the pound, a deeper downturn and a slower recovery than what was forecast by the Bank of England in August, could lead to sentiment for a double-dip recession.

Bank of England now expects the economy to contract in the fourth quarter of the year by 2% which is a 6% downgrade compared to their previous forecast.  

This is almost as much as the peak-to-trough hit in the financial crisis. Over 2020 it will have shrunk by 11% and won't get back to pre-Covid levels on the Bank's projections until 2022.  

Many bank analysts were expecting the pound to rally to between 1.37-1.40 vs the US dollar and slide below 0.9000 towards 0.8800 vs the euro, perhaps even as far to 0.8500.

However, there are some reasons why the pound may not have been able to fully take off on the deal thus far. 

As a consequence of the covid variant, delays of distribution of the vaccine, uncertainty about the Brexit deal's sustainability and full implementation, the pound has been grounded.

Also, with prospects that the Bank of England would need to continue an extensive QE programme or even negative rates, sterling will have a hard time clawing back territory. 

What are other analysts saying about the Brexit update and GBP?

''Moreover, the concept that a deal being struck would put an end to EU/UK negotiations is erroneous,'' analysts at Westpac argued. 

''Talks will be a constant, not only due to the need to gain agreement on Financial and other services but also to ensure that regulatory and legal divergences and changes from either UK or EU will be addressed and agreed upon to maintain the trade deal.''

Meanwhile, analysts at TD Securities argue that they ''do not see this as any game-changer for markets.''

The analysts note that a deal was in the price and the specifics are unlikely to have any bearing on the direction of markets from here.

''While GBP is very cheap across many of our valuation models and much of the negotiation-linked uncertainty can fade, there is still significant economic underperformance and disruptions to follow early in 2021.''

''So we start the year looking to sell GBP on rallies, especially on the non-USD crosses. Overall USD weakness may be able to help cable drift higher through the year, but our current forecasts do not see GBP/USD sustaining gains higher than current levels until the second half of 2021.''

EUR/GBP technical analysis over Brexit latest news

The near-term perspective is clouded by erratic price and volatility leading to choppy and higher ATR values. 

This makes for a difficult market to assess from a technical price action methodology. 

However, the daily chart shows the price in bearish territory below the 10-day moving average and testing a 61.8% Fibonacci retracement level.

The trendline resistance would be expected to be tested firmly on covid fundamentals as the UK enters into new lockdown measures after the Xmas spread, but technically, it would be expected to hold. 

Longer-term, however, there does appear to be a more reliable prospect according to the weekly chart. 

Weekly chart:

Again, the market is directionless and trapped between resistance and support. In fact, the 4-hour chart makes for even further contradiction:

Following a W-formation, a correction to at least the 38.2% Fibonacci would be expected. 

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