Coronavirus is another blow to the UK economy

The virus has struck the UK at a time of much uncertainty about the country’s future relationship with the EU. We believe economic recovery will be muted and remain cautious on sterling.

Thomas Costerg, Senior US Economist & Luc Luyet, Currencies Strategist

Coronavirus is another blow to the UK economy

Given the uncertainties on the health and Brexit fronts, our baseline scenario is for UK GDP growth to drop by 3% this year before rebounding only modestly next year (by 2%), despite relatively solid fiscal and monetary policy measures to absorb part of the coronavirus shock (including a wage-guarantee scheme).

The UK went into this health crisis in a position of economic fragility as GDP had been trending down already. Q4 19 GDP growth was 0.0% q-o-q and 1.1% y-o-y, as business investment continued to flag (mostly because of the ongoing uncertainty about the UK’s future relationship with the EU).  The country is now in full lockdown to stem the spread of the coronavirus. Meanwhile, it remains at this stage unclear how the virus outbreak will affect the UK’s negotiations with the EU over the terms of ‘life after Brexit’. The health crisis has brought negotiations to a halt, yet the UK government has not budged on the year-end deadline for their conclusion. Bottom line, the risk of a UK exit from the EU without a deal on 31 December is on the rise, although this is still not our baseline scenario.

Sterling was particularly weak in the recent market turmoil. Overall, as long as the covid-19 outbreak has not passed its peak in Europe or the US, global risk appetite remains on a fragile footing and does not favour a cyclical currency like sterling. We see it remaining vulnerable in the next few months despite its recent rebound because global risk appetite remains fragile and because of the Brexit uncertainty. Indeed, Furthermore, it seems that investors have not been properly pricing in the risk of another economic shock, this time caused by a very hard Brexit at the end of the year unless the UK changes its stance – and law! – on the transition deadline.  Our current projections for the GBP/USD rate stand at GBP1.15 (three month), GBP1.20 (six month) and GBP1.25 (12 month) per US dollar.

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