While we don’t yet have full-year numbers, it’s clear 2020 saw an unprecedented fall in UK growth (we estimate -10% of gross domestic product, or GDP), materially worse than what was seen in the US and slightly larger than declines in the Euro area.
But the good news is that a recovery from that low base, even if delayed until the spring due to further lockdowns in Q1, means the UK should be able to achieve impressive growth rates as we move through the year – as vaccination momentum builds, lockdowns ease, and households put some of their extra cash to work (we estimate 3.7% and 7% GDP growth in 2021 and 2022, respectively). All of this should be broadly supportive of Sterling in the medium-term (especially with the window for negative interest rates in the UK now firmly shut).
Recent data lend further reason for optimism:
- Monthly growth for November showed a less severe fall than expected: once the most heavily affected sectors are stripped out (hospitality, leisure, retail), service sector declines were relatively modest (especially compared with previous lockdowns), pointing to more resilience than we initially thought.
- Labour market data for December showed a rise in the number of employees for the first time since the pandemic began: while it may be too soon to say whether this is a pivotal turning point, the fact that there weren’t further declines should lead to greater optimism.
- Inflation remains low: we will likely see that step-up with the scheduled reversal of the VAT cut in April, and energy price base effects – the UK’s energy regulator, Ofgem, was aggressive with price caps last year, but those should ease in 2021.
At the same time, the UK-EU Brexit trade deal secured over Christmas, though perhaps not as comprehensive as some had initially hoped, will nevertheless help ease politics & media-driven market jitters that punctuated Sterling movements in the years preceding the agreement. Because of that, we think the risk premium will be lower going forward – in other words, investors will accept a lower Sterling exchange rate to compensate for greater certainty around the outlook.
However, if Brexit-related concerns do persist – particularly if the trade balance comes under pressure due to limited further trade deal progress – and if coronavirus-related scarring is more severe than estimated, that could undermine the currency in the long-term.