Apr 28, 2021 | Foreign Exchange

Britain’s economic outlook and the Pound Sterling

By George Vessey, FX & Macro Strategist, Western Union Business Solutions

Sterling’s appreciation against the US dollar confirmed there have been a number of positive UK macroeconomic developments in recent months. For example, job recruiters reported1 their strongest rebound in permanent hiring for six years in March. However, the longer-term picture is more complex, post-Brexit tensions escalate along the Irish border, Scottish elections also threaten the 4-nation United Kingdom and Britain's vaccine advantage may now be at risk.

Britain’s vaccine advantage now at risk

The world's sixth largest economy is delivering a swift COVID-19 vaccine campaign, particularly relative to its European neighbours. Almost half the total UK population has had a first jab compared with less than 15% in Germany and France2, while only the US has so far given more doses than the UK. 

Amidst an abrupt change in guidance on the use of the AstraZeneca jab - the most widely used vaccine in the UK - concerns about a potential challenge of supply and confidence in the vaccination campaign are mounting. Signs of a reversal in vaccination euphoria are thus increasing concerns of a delayed easing of economic restrictions, although Britain is still expected to reach its herd immunity milestone soon3.

Positive short-term economic factors

Several domestic and international factors will pose risks to UK economic stability with any potential flashpoints hindering its multilateral capacity to deal with material global challenges such as climate change. These factors include:

• Post-Brexit trade barriers and new customs rules

• Political tensions with the European Union and China

• Preserving the 4-nation United Kingdom

Monetary and fiscal policy should support growth

Economic and political factors could dampen the expected rise in consumer price inflation over the course of the year meaning monetary policy is likely to remain accommodative and support economic growth. In conjunction with the sluggish development of the labour market, if inflation remains in an acceptable range for the Bank of England for the next two years, then this should not provoke interest rate hikes.

Greener long-term economic foundations

The UK government is also laying greener long-term economic foundations to fight climate change. Last year, the UK government revealed its proposals for a “green industrial revolution” including the issuance of sovereign green bonds as part of its push to create a net-zero-carbon economy by 2050. Indeed, last month, the government confirmed plans to sell £15bn of green bonds this calendar year4. This would be one of Europe’s biggest green bond issuance programmes, offering retail investors the chance to buy into projects dedicated to fighting climate change.

Post-Brexit risks remain as Scotland now votes

Aside from the macroeconomic landscape, the political environment remains fragile. The impact of the new UK-EU relationship has already caused disruptions in trade across various sectors, with a 40% drop in exports to the EU and a 30% drop in imports from the continent in January5. Although stockpiling can be attributed to this, fish and seafood exports plunged 83% in January mainly because of new veterinary rules.

Elections in Scottish and Welsh parliaments are due in May, and the Scottish National Party expects a landslide victory, which will likely set off rigorous lobbying for a new referendum on independence. The debate about Northern Ireland’s constitutional future is also raging with a growing possibility to hold a so-called border poll, which under the Good Friday Agreement is widely interpreted to mean referendums in both Northern Ireland and the Irish Republic.

Sterling’s 20% gain highlights market volatility

As a consequence of many of the factors discussed in this article – namely the UK’s relatively high vaccination rates, the British pound has strengthened 20% to around $1.4000 against the US dollar since recording a 35-year low of $1.1400 in March 2020. Much of the appreciation cannot, of course, be explained only by positive domestic developments alone, especially since loose monetary policy in the US and increased global risk appetite have induced a rotation of capital into higher-risk currencies such as the pound.

The expected expansion of the UK and global economy has been steadily priced into exchange rates over the past ten months, but this also harbours dangers - especially since the risk of disappointment is now elevated. Meanwhile, if Brexit uncertainties drag on into next year, British companies could continue to suffer from the bureaucratic trade hurdles. Given the cyclical nature of sterling and the UK's current account deficit, the currency remains reliant on continued global risk appetite.

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