Home alone in the UK
The British government continues to insist it will not seek an extension of the Brexit transition period with the EU (scheduled to end on 31 December 2020), despite the external shock caused by the coronavirus and the associated hit to economic activity.
The risk of a hard Brexit without a trade deal on 1 January 2021 is rising, even though our central scenario remains that we will see a ‘midnight muddle through’ with a barebone deal that allows trade negotiations to continue, probably for years.
Expectations of reaching a trade deal by the end of this year were already low before the coronavirus, but recent talks show that consensus is lacking in even some basic areas. Bilateral trade negotiations are stuck in the sand. PM Boris Johnson is set to attend a crucial meeting with the EU Commission sometime later this month in a bid to provide new impetus to the talks.
The UK continues to apply tough restrictions on economic activity to stem the pandemic; non-essential shops will only re-open in mid-June, for example. Consequently, we are reducing our 2020 UK GDP growth forecast to -10.5% from a previous forecast of -8%. The path is still expected to be an asymmetric ‘U’ rather than a ‘V’ (our global scenario is the same).
Meanwhile, several Bank of England (BoE) policymakers have expressed their “openmindedness” about negative rates, but we are still doubtful the central bank will go negative near term. Rather, we think the BoE will opt for more quantitative easing. The BoE’s policy rates are likely to remain rock bottom for a long period, echoing the situation in other developed economies, including the US.
In our House View, we have moved from an underweight stance on UK government bonds to a neutral one, while we have moved from neutral to underweight on the GBP. We remain neutral on UK equities. Provided the post-virus recovery proves relatively robust and trade relations with the EU avoid falling into a ‘black hole’, the 10-year gilt yield could rise to 0.4% by year’s end. By contrast, should we have a no-deal Brexit and should the BoE move to cut rates below zero, the 10-year yield could decline to -0.2% by the close of this year.
We are sticking with our three-month projection of USD1.18 per GBP. Based on our central scenario of a ‘mini-deal’ (rather than a formal wide-ranging trade agreement), sterling will likely rebound. However, this rebound could be modest given the BoE’s accommodative monetary policy, high public debt and a structural current account deficit. We have a 12-month forecast of USD1.30 per GBP, helped notably by the prospect of US dollar weakening (sterling may remain stable at GBP0.89 per euro over that same horizon).
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