Sterling rose on Tuesday (02/02/2021) for the first time since last spring, after the GDP report showed that the eurozone GDP shrank by 0.7% in the last quarter of 2020 and will probably keep shrinking in the current quarter. While this is not as bad as it was expected, fears of a eurozone double-dip recession have risen. Following the news, the euro fell to a nine-month low against the pound. The euro has also dropped to a seven-week low against the US dollar.

For many economists, the EU’s inability to secure a quick vaccine rollout, the prolonged lockdowns and the prospect of further ones will continue to impact on the euro. Additionally, concerns about a double-dip recession are also weighing on the euro. Due to the slow vaccine rollout and the EU’s poor vaccine strategy, commission president Ursula von der Leyen has drawn criticism and had to respond by claiming that the UK’s vaccination programme had compromised on “safety and efficacy” safeguards to get a head start. She said that “Some countries started to vaccinate a little before Europe, it is true. But they resorted to emergency, 24-hour marketing authorisation procedures.” Von der Leyen has also been criticised by Jean-Claude Juncker, but she said that she should be judged in 2024 when her term ends.

Europe’s slow vaccine rollout could affect economic recovery

The slow start to Europe’s Covid-19 vaccination programme could affect its recovery, according to economists. Sam Miley, economist at the Centre for Economics and Business Research said: “The downtick in economic output in Q4 reflects the widespread reimplementation of Covid-19 contain measures across the continent, though does mask varying degrees of restriction severity across member states. This downward pressure on economic output looks set to continue in early 2021 due to the clampdown on new, more virulent strains of coronavirus, while subdued economic activity could continue for an even more protracted period in light of the eurozone’s relatively slower rollout of vaccinations.”

Other economists are also warning that the eurozone is possibly in a double-dip recession now. Christoph Weil, economist at Commerzbank, explained that eurozone GDP will continue to shrink in the January-March quarter, after the 0.7% decline recorded in October-December. “In the first quarter of 2021, the decline is likely to be somewhat steeper. However, there will not be a slump like the one in the first half of 2020. Instead, a noticeable recovery is likely to set in again from the spring.”

Global Chief Strategist at HSBC Global Asset Management, Joseph Little, said:  “The negative Q4 GDP print is confirmation of what investors already knew – a double dip recession in Europe at the end of 2020, with that weakness continuing through Q1. The live question for investors is what the delays in vaccine distribution and virus trends means for the growth outlook as we go through the year. We think the picture should improve through the summer, and that facilitates a ‘catch-up’ phase of growth for Europe in H2.”

UK vaccine rollout

Sterling rose due to optimism about the UK’s vaccination rollout and a wider positive risk sentiment.

The government is expected to vaccinate 15 million with the first dose of the vaccine by the middle of February so all who are clinically vulnerable have some level of resistance against the Covid-19 virus. If the vaccine programme goes as scheduled this, together with the strict lockdown measures will eventually allow the UK government to relax some of the restrictions. This will also help boost the currency. JP Morgan said: "We generally remain supportive of the stronger Sterling view given the impressive vaccine roll out the UK has implemented. Of course, short-term virus worries remain a headwind, particularly as UK lockdowns look set to stay for a significant amount of time.”

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Brexit has been instrumental in the pound’s trajectory, responsible for its collapse and slow recovery. The coronavirus pandemic comes to add more pressure to the pound due to the lockdown measures and the ensuing adverse economic effects.

In the short term, as the UK grapples with the threat of Brexit and the coronavirus, the outlook looks extremely negative. But, how will the pound fair in the long term?

What’s happening now?

Sterling has been hit by Brexit and the coronavirus crisis, with the latter making its effects on the British currency very clear in mid-March, when the GBP plunged to levels not seen in 35 years with anxious traders turning towards safe havens such as the greenback. Until the pandemic is over, analysts predict that the pound will continue to be weak. At the moment, Sterling will remain reactive to headlines concerning the pandemic which has triggered the deepest decline in economic activity since 1929.

Indeed, things have changed a lot since last December when traders felt optimistic about Boris Johnson’s decisive victory in the general election, with many expecting significant progress in the Brexit talks and positive economic data.

Now, with the transition period due to expire at the end of the year and the government saying that it will not ask for an extension, the reality looks different, with the possibility of leaving without a deal posing a real threat to the pound’s future. This means that the UK could fall into a recession as economists have warned.

Short-term predictions

Georgette Boele, Senior FX Strategist at ABN AMRO has said: "In the near-term we expect another wave of risk-off in financial markets as markets are in our opinion too optimistic currently on the speed and strength of economic recovery." Boele added: “There is an enormous gap between the economic reality and what analysts forecast, on the one hand, and the optimism among investors for the second half of this year, on the other. This should support the U.S. Dollar as most liquid safe haven currency."

Long-term predictions

Following Brexit, the forecast for the pound has been dire.  As Brexit troubles are not over yet, and as the coronavirus continues to inject fear in investors, the long-term outlook for the pound is definitely bearish.

Since the June Brexit referendum, consumers have underpinned Britain’s economic expansion as businesses stopped investing. Despite the fall in the pound, consumer spending has grown since the vote, and with many businesses now closed due to the coronavirus, understandably, there are concerns for an economy so reliant on consumption.

With the economy hurt due to lockdown restrictions and a lack of exit strategy, the pound will be under pressure for the long term.

GBP: Investors turn bearish

In the Financial Times article “Investors turn bearish on the pound,” Philip Georgiadis writes that investors are anticipating further falls for the pound and have “increased their bets against the UK pound to the highest level of the year, raising the spectre of a new bout of volatility for the currency.” According to the article, “fund managers and other companies betting in the futures market have turned bearish as concerns over Brexit rise in parallel with the damage the coronavirus pandemic is causing the UK economy.”

Similarly pessimistic is Rabobank which says: “Additionally, insofar as no real progress was made on the last round of post-Brexit talks between the UK and the EU and given that the summer deadline for any request for an extension to the transition phase is looming, it is difficult to be optimistic on GBP.”

Analysts at Danske Bank also find that in the coming months the pound will remain under pressure as “Time spent fighting the coronavirus by both the UK and the EU means less time to negotiate a deal before the end of the year, increasing the risk of a big trade shock by 1 January 2021.”

While overly optimistic valuations might fall to meet reality and as such drive the pound lower, there is also the possibility of the British currency strengthening as the global outlook improves. Sterling’s weakness due to global uncertainty could be reversed as nations successfully fight the virus and recover.

What is certain, is that there are no certainties and the pound could easily come under pressure as optimism withers.

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The pound has dropped to its lowest level since 27 December, after the ONS released its latest GDP estimate for the month of November.

ONS numbers

According to the ONS, the UK GDP grew by 0.1% in the three months to November, while it shrank by 0.3% in November 2019. The contraction in November was worse than expected as uncertainty over the general election and the threat of crashing out of the EU without a deal in October weighed on the economy.

As the ONS figures demonstrate, the services and production sectors grew by 0.1% and 1.1%, respectively in the three months to November 2019, but the production sector fell by 0.6%, its second consecutive rolling three-month decline, while manufacturing output fell by 1.7%.

The ONS stated: “Production fell by 1.2% in the month of November 2019, following growth of 0.4% in October. Within production, manufacturing fell by 1.7%. This was largely driven by large falls in the manufacture of transport equipment, food, and chemicals. These industries were also the main drags on growth in April 2019, just after the UK's original planned date to exit the European Union as shown in Figure 5. This may be indicative of some changes in the timing of activity around the second planned departure in October.”

Today’s figures confirm that the UK economy has slowed for two consecutive months, shrinking in April-June, then showing 0.4% growth in July-September, something which has helped to avoid a recession. It has slowed again to 0.2% in August-October, and 0.1% in September-November.

The Office for National Statistics’ head of GDP, Rob Kent-Smith, said that UK growth was at its lowest level since 2012: “Overall, the economy grew slightly in the latest three months, with growth in construction pulled back by weakening services and another lacklustre performance from manufacturing. The UK economy grew slightly more strongly in September and October than was previously estimated, with later data painting a healthier picture. Long term, the economy continues to slow, with growth in the economy compared with the same time last year at its lowest since the spring of 2012.”

UK economy stagnant

The National Institute of Economic and Social Research (NIESR) noted that the “latest data confirm that UK economic growth had petered out at the end of last year. GDP was virtually flat in the 3m to Nov & latest surveys point to further stagnation in Dec. The short-term economic outlook is for more lacklustre growth.”

More importantly, the idea of the Bank of England having to cut interest rates has resurfaced as investment strategists and traders have mentioned.

Bank of England: Interest rate cut?

The latest GDP data has boosted the chances of UK interest rates being cut soon, possibly at the Bank of England’s meeting at the end of January. Matthew Cady, investment strategist at Brooks Macdonald, said: “UK GDP for November has come in at negative -0.3%. This is quite a bit weaker than had been expected. Consensus had been looking for zero growth month on month. Against this, both September and October were revised up by 0.2% and 0.1% points respectively. The weaker GDP print today puts beyond doubt that the next Bank of England meeting at the end of January is going to be a ‘live’ meeting.”

Peter Dixon, economist at Commerzbank, said that the possibility of an interest rate cut has risen to 50%: “With a growing chorus on the MPC apparently open to the prospect of a rate cut, if the data points in that direction, today’s release might well tip the balance of one or two members ahead of the meeting on 30 January, where the market probability assigned to a 25 bps cut has risen to 50% versus 5% at the start of last week.”

However, it is also wise to be positive and consider the GDP numbers as indicative of a specific time period rather than of a future trend, as business confidence can return after Boris Johnson’s election. As chief economist at PwC, John Hawksworth, clarified, today’s data relates to a specific “period of heightened economic and political uncertainty” and that “our latest survey of the financial services sector with the CBI does suggest some boost to optimism since the election.”

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