Highlights
The near-term outlook for UK assets and the GBP has improved following May’s Bank of England (BoE) meeting and the Scottish parliamentary election results announced over the weekend.
First, the BoE kept its Bank Rate unchanged at 0.10% and its overall size of quantitative easing also the same at GBP895 billion, finishing at the end of the year. But the BoE upgraded its economic forecasts, prompting its Monetary Policy Committee (MPC) to vote to start tapering its bond buying, becoming the first major central bank to slow down asset purchases this year.
The chart shows UK inflation has fallen sharply below the BoE’s 2% target during the pandemic and is currently just at 0.7% in 2021. Similarly, unemployment has risen from 3.8% in 2020 to as high as 5.0% this year and would be significantly higher if the UK government had not set up its huge Jobs Retention Scheme last year. The UK’s fast vaccinations, however, have shifted the outlook markedly. We forecast 2021 GDP growth at 6.0% while the BoE is forecasting 7.25%, returning the economy to its pre-pandemic size by the end of the year. Thus, the MPC voted to taper its bond buying. This steepened the yield curve to the benefit of UK financials and the GBP.
The BoE still projects inflation to be at its 2% goal in 2022 and 2023 after a temporary overshoot this year. Thus, interest rate hikes before 2023 remain unlikely in the UK. But the central bank’s tapering of its quantitative easing now will push the GBP towards our 1.44 forecast versus the USD.
Source: Bank of Singapore, Bloomberg
Second, the Scottish parliamentary elections resulted in the Scottish National Party (SNP) falling short by one seat of gaining an outright majority.
The SNP wants to hold a second referendum on Scotland’s membership of the UK, following the earlier 2014 vote on independence that was rejected by 55% to 45%. The SNP argues that since a majority in Scotland voted to remain in the European Union when the UK as a whole voted to leave the EU in 2016, Scottish voters should now have a second independence vote.
The SNP and other pro-independence parties including the Greens did secure a combined majority this month. But the SNP’s failure to gain a majority alone and the UK government’s opposition to granting the Scottish parliament the legal authority to hold a second referendum - arguing the 2014 vote settled the issue ‘for a generation’ and politicians instead should focus on the pandemic - has reduced the immediate risk of another independence vote. Thus, the GBP rallied though 1.40 against the USD today.
If the pandemic eases in 2022, however, the SNP may push for a second referendum. Uncertainty over an independent Scotland’s future currency, its significant financial sector and the stationing of the UK’s Trident nuclear submarines would hit the GBP and local assets.
But the UK government is set to resist, making a second vote unlikely to be held until 2023 or 2024. By then support for independence may have fallen from the current 50-50 even split amongst Scottish voters for and against leaving the UK.
