Will the Pound Continue to Fall?

GBP EUR Exchange Rate: Week in Review August 28th

The pound ended the week more than 1.5 per cent lower against the euro and 0.5 per cent lower against the US dollar, closing at 1.0998 and 1.2567 respectively. It was another difficult week for the UK currency as Brexit nervousness, poor economic data and investors risk appetite all weighed on the pound. Will the pound continue to fall into next week?

Key UK GDP data for the month of May fell well below market expectation of 5 per cent with a reading of 1.8 per cent, which means the UK economy is now 24.5 per cent smaller than 5 months ago, prior to the COVID-19 lockdown.

Andy Haldane, Chief Economist of the Bank of England had suggested that the UK was showing signs of a v-shaped recovery less than three weeks ago but this data has asked serious questions about that statement with many economists now believing the UK economy will endure a much slower recovery.

The poor GDP data has also raised questions over the Bank of England’s monetary policy and the possibility for interest rates to move lower to zero or negative. Key BoE members have refused to rule out the possibility of a move lower on interest rates and this has contributed to keeping the pound low against the euro and US dollar. Whilst, no immediate change to the current 0.1 per cent interest rate is forecast, if economic conditions remain gloomy, the bank could look at a rate cut later this year. A zero or negative interest rate would almost certainly be negative for pound to euro and pound to US dollar exchange rates.

Pound Unlikely to Move Higher Unless Brexit Deal Agreed

It is unlikely the pound will move significantly higher against the euro or US dollar unless a Brexit trade deal is agreed. The UK and EU have until the end of the year to reach a Free Trade Agreement but in order to get the deal ratified by the European Parliament before the end of the transition period and avoid that cliff-edge, a deal needs to be agreed by late October.

As we’ve seen before, Brexit trade progress has a huge influence on the value of the UK currency, with the pound rising when the UK seems it’ll align closer to the EU and falling when the UK distances itself from the EU. This trend will likely continue until we see significant progress in the negotiations.

Whilst there has been little progress reported, the tone from both the UK and EU has been considerably more constructive in recent weeks and whispers from EU diplomats have stated that the two parties are working on a “landing zone” which would provide the foundation to a Free Trade Agreement. In public both the UK and EU have conceded little but the landing zone would require compromise on both sides and it is believed, both sides are working tirelessly behind the scenes to map out areas of compromise.

EU access to UK fishing waters is a key area of difference. The UK is keen to take back control of its waters and grant annual access to the EU whereas the EU has insisted that an agreement on fishing is a prerequisite of an FTA. The EU recently conceded some ground on this matter but we still appear to be a long way from seeing a solution.

The EU’s request for the UK to commit to a “level playing field” is another area of difference and likely a matter that will be considerably more difficult to resolve than fishing access. Here, the EU wants the UK to sign up to EU rules so that UK businesses do not undercut their European rivals but this would involve UK businesses following EU law and ultimately being subjected to the European Court of Justice in times of dispute.

It is not obvious how this difference will be resolved and this could ultimately be the problem that puts the UK and EU on World Trade Organisation rules (aka “no deal”), although it has been suggested that a solution is possible. Perhaps the UK may adhere to certain regulations but not be compelled to comply with laws introduced after the transition period officially concludes? This could soften the economic risk to begin with but allow the UK to diverge over time.

Most do expect the UK and EU to reach a trade deal and consider a “no deal” scenario unlikely, with less than a 20 per cent chance, although it is unlikely anything concrete will materialise until the Autumn months leaving the pound under pressure against the euro and US dollar in the interim.

On the basis that a Free Trade Agreement is reached in October, pound to euro could head towards 1.20 and pound to US dollar towards 1.35 by year-end, but if a deal is not concluded the pound could be looking at a 5-10 per cent drop from current levels.

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