The Brexit transition period with the EU is coming to an end in December 2020, and the British government insists that it will not seek an extension of it. AThe potential for hard Brexit at the start of 2021, coupled with the exogenous shock created by the coronavirus pandemic, puts the United Kingdom’s economy at high risks moving forward.
Problems Ahead for the Bank of England
The Bank of England (BOE) faces a unique and complex situation in the months ahead. On one hand, it must set the right monetary policy to ease the economic shock created by the coronavirus pandemic. In this regard, it acted very closely with the British government, coordinating its moves to complement the fiscal stimulus.
On the other hand, unlike other central banks, it must consider the implications of the ongoing negotiations between the UK and the EU. In the meantime, the UK’s real GDP growth is diving.
The UK and the EU continue to disagree on fundamental principles, and a consensus is lacking. If one looks at the UK economic activity and compares it with peer economies (e.g., Germany, US), the UK is lagging by far.
The risk of a no-deal exit in January implies a high economic cost that goes beyond the coronavirus impact. The 2020 GDP growth forecast is already revised lower by many economists, to below -10%.
Voices at the BOE, including the new Governor Andrew Bailey, tested the markets recently by discussing the possibility of negative interest rates in the UK. While just a scenario at this point, it may be a way to see how the financial markets and the City could react to such a possibility.
In any case, in the event that the BOE decides to go on the negative rates path, it is unlikely that it will do that before extending the QE program. Therefore, traders and investors will interpret any extension in the quantitative easing size as a step closer to negative interest rates in the United Kingdom.
In the meantime, the IHS Markit Manufacturing PMI index was weak in May (40.7), and retail sales in April fell 22.6% YoY. With the bilateral trade negotiations with the EU stuck and the ongoing economic shock created by the coronavirus pandemic, the risk is that the United Kingdom’s economy will face tougher problems than the rest of the developed world.
All eyes on the GBP!