The pound saw little movement during yesterday’s trading as pound to euro consolidated above 1.12 and pound to US dollar held above 1.27. Although last night’s US Federal Reserve meeting has sent to both pound to euro and pound to US dollar lower, now trading at 1.1165 and 1.2680 respectively. Whilst there was no immediate change in policy, Fed Chair Jerome Powell reiterated his commitment to support the US economy. This provided a needed boost to the US dollar as markets took comfort that the Fed would not be changing course.
Since the UK and EU committed to continue trade discussions through until the end of the year, the downside risk has lessened, and this has been evident in the number of traders cutting their sterling short positions. However, the pound is likely to remain under pressure as a multitude of UK based problems keep the currency weak.
The lack of progress in Brexit trade talks and the refusal of the UK to request an extension to the current transition period, due to end on 31 January 2021, had threatened to push the pound lower, with both Barclays and Commerzbank predicting pound to euro to fall below 1.10 in the near-term. However, unlike previous trade meetings, both David Frost and Michel Barnier struck a more optimistic tone when the last round of trade talks concluded on Friday, stating they would both continue to work constructively towards a free trade agreement.
It is now widely accepted that the UK will not request an extension to the current transition period, meaning the UK and EU will have until the end of the year to strike a free trade agreement. That said, the EU parliament will need to ratify any FTA, so the UK and EU only have until late October to get a deal agreed.
The UK is keen to begin face-to-face negotiations with the EU in July, but Michel Barnier has pointed towards October as a more realistic date, making the Autumn month the make or break moment. The EU has bigger problems that it needs to address right now, namely focussing on the 7-year budget without the UK’s contribution, and approving the European Commission’s €750 billion COVID-19 rescue fund, which will kick in next year with the new budget. Both issues are likely to involve heated discussions between nation states as they battle to reach an agreement.
Furthermore, the EU will need to contend with the recent decision by the German supreme court which deemed the European Central Bank (ECB’s) bond buying programme between 2015-2018 illegal. The ECB has until early August to provide an acceptable explanation, otherwise risk the German Bundesbank withdrawing from further asset purchases and offloading the current ones. This could make for an explosive encounter early August and could send pound to euro higher if common ground cannot be found. The alternative would be that the ECB continues its quantitative easing scheme without the Bundesbank. This seems absurd and would seriously bring into question the sustainability of the monetary union, but this is what the ECB is currently preparing for behind the scenes.
The immediate focus will be on top level discussions between Boris Johnson and EU leaders next week as EU leaders meet for the European Council meeting. Leaders will discuss Brexit progress and how the current deadlock can be broken. It is hoped that both teams can adjust their red lines and push negotiations forward.
Slow Easing of Lockdown Measures Likely to Weigh on the Pound
With the cliff-edge Brexit now temporarily off the radar, the pound to euro and pound to dollar exchange rates will be more reactive to wider sentiment and one of the immediate concerns is the lack of progress in opening UK schools. The government’s change in approach means schools will not open as planned and this will slow down the UK’s exit from lockdown, impacting the UK’s return to growth. It is important for the economy that children return to school in order to increase output in the education sector, but more importantly, allowing parents with young children to return to work.
Other economies such as the antipodean, Canadian and Eurozone economies are significantly ahead of the UK in their easing of lockdown measures, as they strive towards returning to pre Covid-19 GDP levels, so with the UK lagging behind, this could also weigh on pound to euro and pound to dollar exchange rates.
There are the signs that UK economy is recovering, and most expect growth in May and June although given the sharp collapse in Gross Domestic Product data in previous months, the economy has a long way to go before it reaches pre COVID-19 levels. Many had hoped for a “v-shaped” recovery but this is increasingly unlikely as most now accept the UK’s recovery will be much slower and likely take at least 18 months.
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