UK economic growth, equity markets and GBP have all underperformed over the last five years following the shock result of the 2016 referendum to leave the European Union (EU).
Source: Bank of Singapore, Bloomberg
The vote led to political turmoil with three prime ministers and two early elections. The risk of a ‘no deal’ exit from the UK’s trading arrangements with the EU when Britain ceased being a member, made local and foreign firms operating in the UK pause their investments for years.
The 2020 pandemic also hit the UK much harder than its peers. The government’s late initial response and subsequent stop-start lockdowns caused growth to slump. We forecast UK GDP to fall by a staggering -10.5% in 2020 - by far the worst record of any of the major economies.
Source: Bank of Singapore, Bloomberg
Thus, UK equities are still below their pre-pandemic levels of early 2020 - in sharp contrast to the S&P 500 - and the GBP at 1.37 against the USD is below 1.50, its level on the day of the 2016 EU referendum, as the first chart shows.
But the UK outlook is reaching a major turning point now to the benefit of domestic markets. First, the UK and the EU struck a fresh trade treaty at the end of December, enabling exports and imports to continue without tariffs. The deal at last removed a major risk that had been clouding the economic outlook for the last five years.
Second, in contrast to its poor handling of the pandemic in 2020, the UK government is leading the way in vaccinations in 2021. We forecast GDP to rebound by 4.5% this year as infections ease.
Third, the Bank of England - having cut its Bank Rate to an all time low of 0.10% during the pandemic as the second chart shows - now appears less keen to lower interest rates into negative territory as UK growth picks up again when Britain’s current winter virus waves subside. In addition, inflation is currently well below the central bank’s 2% target.
But December’s data was stronger than expected. Headline inflation rose to 0.6%YoY and core to 1.4%YoY.
The risk of inflation increasing over 2021 will also deter the BoE from cutting interest rates below zero. The UK’s stronger outlook for the first time in five years is thus likely to draw investors back. We forecast the GBP will rise to 1.44 against the USD
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Version: July 2020