Sterling rose after a Bloomberg article yesterday (28 October) reported that a Brexit deal was closer into view as talks progressed. Both sides were participating in an intensive round of negotiations in London, and, on Thursday, the talks will move to Brussels. If more progress is made by 3rd of November, the UK Prime Minister Boris Johnson and European Commission President Ursula von der Leyen will then have to negotiate a final agreement.

Today, though markets remain nervous ahead of the US GDP and ECB meeting as the escalating Covid-19 pandemic has triggered renewed fears of a double dip downturn. With a second lockdown in France and new restrictions about to be imposed in Germany, investors are on edge.

Pound rises on Brexit progress

European Union and UK negotiators managed to resolve “some of the biggest disagreements that have long bedevilled the Brexit talks, raising hopes that a deal could be reached by early November, according to people familiar with the discussions,” Bloomberg noted.

According to the article, sources said that the deadlock has been broken after seven months of negotiations, but traders will still need to see more solid evidence to be convinced of any progress. The sources reported that both sides are working on “the text of an agreement on the level competitive playing field and are close to finalizing a joint document covering state aid.” They have also “moved closer to deciding essential aspects of how any accord will be enforced,” the sources added.

The news pushed the pound higher against the Euro and the majority of its G10 peers. While markets remain cautious, some economists believe that there are positive signs for reaching a trade deal.

The Brexit news should offer support to a pound that has been very sensitive to Covid-19 developments, at a time where lockdowns are devastating economies. In the event of a second wave the pound will definitely remain sensitive and could weaken, and analysts say that positive Brexit news might not be enough to support the pound in the current volatile environment. In this respect the upside potential for the pound is seen to be limited, as many more issues remain to be resolved regarding the Brexit talks, despite recent news.

Despite the recent doom and gloom, there are potential business opportunities to be had with Brexit, “from fishermen to airlines and insurers,” according to an article.

Risks to the pound

Sterling has been sensitive to Covid-19 updates and Brexit news, and it will remain so. According to Pound Sterling Live, “An obvious risk for those watching Sterling exchange rates is that negative Brexit news - which would most likely be a stalemate on fishing - combines with 'risk off' market conditions to trigger substantial declines in value.” But the stimulus support from Central Banks might be enough to support world economies and protect from unexpected currency declines seen in the aftermath of the first wave of Covid-19.

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The UK economy has shrunk sharply in the first quarter of 2020, according to the Office for National Statistics (ONS). Sterling fell initially, but then stabilised after the British government extended its furlough scheme until the end of October.

GDP

GDP fell 2.0% fall in the three months to March after there was no growth in the three months to February. Particularly, March was a terrible month for the economy, as the GDP dropped by 5.8%, marking the worst performance since the ONS started calculating monthly data back in 1997.

While the UK economy before the Covid-19 lockdown was not faring well, contracting by 0.2% in February, as the coronavirus pandemic started, in March, however, it suffered dramatically. The drop in the first three months is considered to be the biggest quarterly drop in activity since 2008 after the collapse of the Lehman Brothers and the beginning of the global financial crisis.

Yesterday, chancellor Rishi Sunak warned that the UK recession was “already happening”, and that things will not improve in the near future. Last week, the Bank of England forecast that the UK economy might contract by 25% in the April-June quarter, which could be the deepest recession in three centuries.

Decline in Services, Manufacturing and Construction

The ONS reported that in March, with the beginning of the lockdown, the GDP contracted by 5.8% with the services sector shrinking by 6.2% during March, manufacturing output dropping by 4.6% during the month and construction contracting by 5.9%.

The Office for National Statistics explains that there is a close connection between the lockdown measures and the drop in economic activity:

In response to the coronavirus (COVID-19) pandemic, public health restrictions and social distancing measures have been put in place in the UK, leading to a widespread disruption to economic activity. These measures have impacted upon the spending behaviours of consumers as well as how businesses and their employees operate. It has also affected the provision of services provided by government, including health and education.

Services output decreased by 1.9% in Quarter 1 (January to March) 2020, the largest quarterly fall since records began. Production output fell by 2.1% in Quarter 1 2020, driven by declines in manufacturing. Construction output decreased by 2.6% in the first quarter.

According to Jonathan Athow, deputy national statistician for economic statistics, in March, the coronavirus pandemic hit the economy hard, with certain industries such as services and construction declining sharply and others, such as IT support and pharmaceuticals seeing growth.

Key points from the release:

The release reflects the dire effects of the coronavirus pandemic and the economic disruption to various sectors. March was the worst month as education fell by 4.0% due to school closures, wholesale and retail trade and repair of motor vehicles and motorcycles by 10.7%, food and beverage service activities by 7.3% and accommodation by 14.6%. The travelling sector was also hit falling by 23.6% while transport equipment-making declined by 20.5%.

What economists say:

Talking on Sky News, Sunak said that the government was positive and could “emerge stronger” on the other side. He said: “In common with pretty much every other economy around the world we’re facing severe impact from the coronavirus. You’re seeing that in the numbers. That’s why we’ve taken the unprecedented action that we have to support people’s jobs, their incomes and livelihoods at this time, and support businesses, so we can get through this period of severe disruption and emerge stronger on the other side.”

However, Tej Parikh, chief economist at the Institute of Directors, fears that Britain will not “emerge stronger” from the lockdown as he believes that UK firms will remain under pressure:

While countless companies have made adjustments with admirable speed, many will find it difficult to operate at anything like normal capacity under social distancing rules. The furlough scheme has undoubtedly staved off redundancies, and the new flexibility provides businesses a better chance of rebooting.

The Treasury will need to continue innovating to kickstart any recovery. The Government’s loan scheme provided ready cash, but now leaves many firms saddled with debt. Unless this is managed well, it will drag on business investment for long after the lockdown ends.

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Sterling was under pressure after Friday’s British retail sales figures showed that sales fell in March, despite an increase in consumer goods, particularly alcohol.

This was the biggest fall since 1996 when the Office for National Statistics (ONS) began recording the figures. As Rhian Murphy, ONS head of retail sales said, “Retail sales saw their biggest monthly fall since records began over 30 years ago with large declines in clothing and fuel, only partially offset by strong food sales. The “retail armageddon” as was described by Ayush Ansal, chief investment officer at hedge fund Crimson Black Capital, was a reflection of the Covid-19 pandemic.

The pound has been sensitive to gloomy economic figures but also coronavirus updates, as the foreign exchange market is watching to see how the country deals with the lockdown and how fast it recovers.

UK retail sales: Economists predict further fall in April

Thomas Pugh of Capital Economics noted that the record fall in UK retail sales last month demonstrates that consumption has fallen during the lockdown:

“At one end, there were clear signs the pandemic was keeping consumers away from the high street, non-food sales excluding petrol and online sales were down by 19.4% m/m, with an especially sharp 34.8% m/m fall in clothing sales. And petrol sales declined by 18.9% m/m. Department store sales did rise by 2.8% m/m, but appears to be due to purchases of food and other items online. On the other hand, food & drink sales were up 10.4% m/m (within that alcohol 31.4%!) and online sales (non-department store) rose by 5.9% m/m, as consumers were locked down at home.”

But the fall in March is only the beginning, as economists believe that April will post a bigger fall. Alan Custis, head of UK equities at Lazard Asset Management, says that “the real story will be seen in April’s figures when the lock-down will be fully felt by retailers. Here we expect to see dire numbers, but it must be balanced up by very strong online sales, which we expect will be showing growth in excess of 50% year on year. There have been clear winners and losers and we think this will only become more apparent the longer the crisis continues.”

Consumer confidence at its lowest

Further disappointing stats did nothing to support the pound. On Friday, data from the research company GfK showed that British consumer confidence was at its lowest in April.

The balance of consumers who were considering making major purchases dropped to minus 52 in April, while, the net balance of those expecting their financial situation to improve dropped to minus 14. Howard Archer, chief economic adviser at the consultancy EY Item Club said: “The near-term fundamentals for consumer spending have clearly taken a very substantial downturn as a result of coronavirus. Many people have already lost their jobs, despite the supportive government measures while others will be worried that they may still end up losing their job once the furlough scheme ends.”

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With the coronavirus continuing to affect the UK economy and the issue of securing a Brexit trade deal persisting, the British Pound is forecast to struggle, with investors’ growing increasingly anxious.

While worries about the coronavirus pandemic overshadowed Brexit temporarily, political concerns return as the government has highlighted its reluctance for a Brexit extension.

Brexit: No extension

With the transition period due to end on 31 December and with only three rounds of trade talks remaining, the UK would need to negotiate a trade deal by December 2020, especially when the government says that an extension would only "prolong the delay and uncertainty" around Brexit.

David Frost, the UK's chief negotiator and Michel Barnier, the European Commission's chief negotiator, after their Wednesday meeting via video conference, agreed on three weeks of talks beginning on 20 April, 11 May and 1 June. In a joint statement, they recognised that their work has helped to "identify all major areas of divergence and convergence", but further negotiations were needed "to make real, tangible progress in the negotiations by June."

But the UK government has clarified that no extension would be asked from the EU, despite recent calls by International Monetary Fund Managing Director Kristalina Georgieva to extend the period for negotiations and not "add to uncertainty" as a result of the coronavirus.

However, the prime minister's official spokesman said: “We will not ask to extend the transition period, and if the EU asks we will say 'no.' Extending the transition would simply prolong the negotiations, prolong business uncertainty and delay the moment of control of our borders. It would also keep us bound by EU legislation at a point when we need legislative and economic flexibility to manage the U.K. response to the coronavirus pandemic.”

David Frost has also similarly clarified the government’s intentions: “Extending would simply prolong negotiations, create even more uncertainty, leave us liable to pay more to the EU in future, and keep us bound by evolving EU laws at a time when we need to control our own affairs. In short, it is not in the UK's interest to extend."

The Prime Minister’s confidence in striking a satisfactory trade deal by the end of the year has been criticised by the opposition, with Liberal Democrat Sir Ed Davey saying that the refusal to extend the transition was "deeply irresponsible."

Concerns have also been voiced by the financial world. Economists and strategists have warned about the risks for the pound and have noted that uncertainty typically has driven investors to sell the pound against every other currency. Analyst at Thomson Reuters Richard Pace noted: “GBP dealers should fear July 1, when it will be too late to extend the Brexit transition past Dec. 31, 2020, and GBP would rightly suffer. The UK government has been vehement about not asking for an extension, and the UK parliament won't be able to force one this time, since Prime Minister Boris Johnson's huge Conservative majority will back his decision."

“Tough Times” for UK economy

It is not only the current uncertainty with Brexit, but also the coronavirus’ effects that will deeply hurt the pound and the economy. Chancellor Rishi Sunak has said that the coronavirus will have "serious implications" for the UK economy, as the Office for Budget Responsibility (OBR) is expecting that the virus will shrink the economy by 35% by June. Sunak said that the government needed to be honest and that the OBR’s figures suggest that the UK is facing “tough times, and there will be more to come.”

While the government is "not just going to stand by" and will try to protect “millions of jobs, businesses, self-employed people, charities, and households," the effects of the lockdown cannot be minimised.

Robert Chote, the chairman of the OBR, said that a three-month lockdown followed by another three months of partial restrictions would see the economy declining sharply, a drop that would be the biggest "in living memory."

The International Monetary Fund has also warned that the virus would cause the UK economy to shrink by 6.5% in 2020, and the global economy to contract by 3%.

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