The pound to US dollar currency pair rose early on Monday and reached a one-week high, but later lost its traction. Analysts have warned that gains will be limited due to dovish BoE expectations, Brexit concerns and recession fears.
Brexit and Northern Ireland protocol
The gains for the pound will be limited as markets remain cautious over concerns regarding the post-Brexit trade agreement. UK MPs will vote later on Monday on legislation that would allow them to make unilateral changes to the post-Brexit deal and remove checks on goods entering Northern Ireland from the rest of the UK. The European Union has expressed its disagreement with such a move and said that it would violate international law. British Prime Minister Boris Johnson said on Monday that he intends to turn the legislation, if approved, into law by the end of the year. He has also said that the plan will restore the balance of the Belfast/Good Friday agreement, despite that some Conservative backbenchers are concerned it breaches the rule of law.
Post-Brexit trade deal and recession concerns
The UK government’s attempt to remove parts of the Northern Ireland protocol could add to inflationary pressures that could push the UK into recession. According to academics at the University of Liverpool Management School, the Northern Ireland Protocol Bill will trigger economic policy uncertainty. An article published in the LSE’s Business Review, by professor Costas Milas and lecturers Michael Ellington and Marcin Michalski, argues that rising economic policy uncertainty and higher interest rates will weigh on the economy. They wrote: “Our belief is that by pushing forward with this very bill, Johnson’s government will unnecessarily add to existing economic policy uncertainty. Indeed, how many counties around the world will be willing to sign trade agreements with the UK when Johnson’s government has been accused of breaching international law? This will fuel economic policy uncertainty but also hit the country’s trustworthiness in international markets therefore increasing the interest rate that investors demand to bring, or even keep, their money in the UK.” They added that economic policy uncertainty and higher interest rates will push the country into a recession.”
Rising recession fears and geopolitical tensions are threatening to push the UK economy into recession. According to KPMG’s latest UK Economic Outlook report, released on Monday morning, the cost-of-living crisis could push the economy into “a mild recession” in 2023. The Ukraine war and China lockdowns have added further pressure on supply chains and pushed commodity prices higher.
KPMG has noted that UK GDP growth will fall to 3.2%, before slowing further to 0.7% in 2023. They said that policy actions to fight inflation and any further issues resulting from geopolitical tensions could bring about another recession. They mentioned aggressive monetary tightening by the US Fed, interruptions of gas supplies from Russia, and additional shock to global wholesale gas and oil prices. In the UK, a potential recession will be the result of a further squeeze on UK households and a sharper decline in household consumption.
A growing number of economists anticipate that America could fall into recession next year, while Europe’s economy has shown signs of a slowdown too. With UK inflation at 40-year highs, consumer confidence has hit record lows, as people are struggling with their finances and have cut spending.
Disappointing UK macroeconomic data, concerns about the UK economy slowing down and diminished expectations of further rate hikes as the Bank of England chooses a more gradual approach towards raising interest rates have acted as headwinds for the pound. The current tensions between the UK and EU about the Northern Ireland protocol have also weighed on the pound to US dollar currency pair.
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