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Weekly market recap – Spiralling sterling

According to a survey in The Times, only 3% of Britons admit to having breached the lockdown rules by leaving the home for non-essential reasons during the past week. When the survey is anonymised however, this figure jumps up to 29%! When the respondents were asked if they had met up with friends and relatives from other households, 8% said yes (31% said yes anonymised) and 15% admitted to breaking the two-metre rule (up to 35%).

Markets took a dive last week as they perhaps only now have started grappling with the reality that social lockdowns won’t stave off the virus indefinitely. Asset class returns in sterling and local currency are below; with both Brexit and trade wars back on the news wire last week, sterling – considered a risky asset amongst international investors – fell over 2% as traders reassessed prospects for further monetary easing.

Table 1: GBP total returns

Source: Bloomberg

Table 2: Local CCY total returns

Source: Bloomberg

If we cast our minds back to what feels a lifetime ago – January of this year – we will remember that the UK’s departure from the European Union ushered in a transition period between the UK’s membership and its independence. This was originally designed to bridge the gap between full EU-membership and a new economic partnership in order to minimise disruption for business. So far so good.

Under the original timeline set out by version one of the 500-plus-page Withdrawal Agreement (i.e. the version negotiated during the May Ministry), the UK would have departed the bloc in March 2019 with a 21-month transition period taking us up to 31 December 2020. After this point, the transition period would cease to exist and the new economic partnership (as negotiated during the transition period) would be enacted. As a precaution, the two sides built a mechanism within the Withdrawal Agreement to extend this transition period should more time be required for trade negotiations. The deadline for extending the transition period was set 6 months before the end (30 June 2020).

Numerous delays to the official departure date and the failure of both sides to address the new compressed timeline in version two of the Withdrawal Agreement has created a new pressure. So, as the world has been immobilised by Covid-19, time has continued to tick down on the Brexit clock.

Chart 1: The original timeline (indicated by the blue dotted line) allowed 21 months of transition period within which to negotiate a trade agreement. The revised timeline as per the renegotiated Withdrawal Agreement (indicated with by the pink line) has provisioned just 11 months.

Source: EQ Investors

With the Conservative Party having won a significant majority in the House of Commons with a ‘Get Brexit Done’ agenda, the likelihood of the Prime Minister rowing back from an earlier pledge that he wouldn’t extend the transition period looks slim. Thus, the perception among economists is that the UK economy, already crippled by the Covid-19 lockdown, will face another major headwind coming out of this crisis.

Source: Bloomberg

As we know from market moves since the referendum, one of the biggest casualties of a negative UK outlook is the pound. This reflects traders’ views that interest rates set by the Bank of England may fall further than other economies as the central bank attempts to move further into accommodative territory. We can expect the whole debate around a ‘no deal’ scenario to resurface in the coming weeks as we approach the extension deadline in June.

STAT OF THE WEEK: £298.4 billion – estimated UK public sector net borrowing this year under the OBR’s newly updated ‘reference scenario’ (Office for Budget Responsibility).

DATA CORRECT AS AT: 15/05/20

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