Three and a half years following the Brexit referendum, the UK is set to finally exit the European Union (EU) on 31 January and move into a transition period.
After years of being politically driven, a shift in focus back to the UK economy is likely to skew the risk in favour of buying GBP on dips in the first half of 2020. However, the risk of a no-trade-deal Brexit replacing the risk of no-deal Brexit could weigh on the GBP outlook in the latter half of this year, leaving us with mixed feelings on the GBP’s overall prospects in 2020.
The UK economy finished 2019 weaker than the Bank of England (BoE) expected. It may well be the case that the underperformance of the economy over the last few quarters still justifies policy easing even though BoE passed on a rate cut in January. However, tentative signs of UK growth bottoming suggest any monetary easing to be a “one-off”.
Signs of life in post-election animal spirits is GBP-positive
Source: Bloomberg, Bank of Singapore
Animal spirits are showing signs of life. Measures of business confidence have rebounded, presumably cheered by the Conservative Party’s sizable election win in December, which not only avoided a hard-left government but has also paved way for an orderly legal exit of the UK from the EU.
Ahead of the UK budget in March, the Conservatives have already pledged an increase in fiscal stimulus, which will also provide some impetus to the UK economy. Along with a relatively resilient labour market with low unemployment and rising real wages, all this should support a gradual UK recovery back to trend growth later this year.
What next for UK politics and Brexit
Source: Compiled by Bank of Singapore
While the first phase of Brexit -- ‘the divorce’ -- is coming to a conclusion, the complicated second phase is just beginning. Britain must negotiate a trade deal governing future commercial relations with the EU. The negotiations will be both complicated and limited, given the timing. The transition period, during which little changes despite the formal Brexit, runs only until end 2020.
PM Boris Johnson has ruled out extending the post-Brexit transition period beyond December 2020 to accommodate the lengthy trade negotiations with the EU. The next binding decision date is 1 July, which is the scheduled deadline for requesting an extension to the transition period.
It is possible that Johnson may – at the eleventh hour -- be willing to extend the transition period and also offer concessions on regulatory alignment and free movement of labour to secure frictionless trade. But if Johnson holds firm, it would mean either the UK and EU strike a narrow trade deal that governs some manufactured goods, while leaving out services — the bulk of the British economy — or that the UK crashes out of the EU with no deal at all. Leaving without a trade deal, or even with just a narrow trade deal covering just trade in goods would justify renewed GBP weakness. We therefore struggle to extend the buy GBP on dip rationale beyond mid-2020.Disclaimer applicable to recommendation
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Version: December 2019