By Jameel Ahmad, Global Head of Currency Strategy and Market Research at FXTM
Two months of political uncertainties certainly took its toll on the Pound Sterling. Having shed some 1.7% against the US Dollar since Theresa May’s resignation announcement on May 24, but nearly 5% since early May when speculation ran rampant that the former Prime Minister would need to step down. The Pound offered a muted response in the immediate wake of confirmation that former London Mayor and Foreign Secretary, Boris Johnson had become the new UK Prime Minister as largely expected.
With a new PM installed, Pound investors have naturally turned attention towards asking – “What’s next for Brexit?”
Johnson has repeatedly emphasised that he will definitively take the UK out of the European Union by October 31, with or without a deal. Still, it remains to be seen how he can overcome the same challenges which ultimately led to his predecessor’s resignation. Although Johnson has his party’s strong support, there are no guarantees he can get Parliament to give him the green light. Brexit’s path ahead appears mired with political landmines, similar to the ones that Theresa May constantly faced, which ensures that the Pound remains politically-sensitive at least until the current Brexit deadline, which is less than 100 days away.
Recession risks rise as Brexit saga rolls on
The new Prime Minister now helms an economy which is already forecast to be in a technical recession as of the second quarter, at least in the eyes of the UK’s National Institute of Economic and Social Research. A no-deal Brexit is widely expected to tip the UK economy over the edge, with the Bank of England having waved the red flag since November 2018, estimating that a worst-case scenario could see the UK economy slump by 8%. Such bleak projections have only served to keep the Pound subdued.
Even the silver lining in a weaker currency wouldn’t necessarily apply to the UK. Often in the case of a depreciating currency, the country’s exports become attractive because they’re more affordable given the exchange rates against peer and emerging currencies. But in this case, a no-deal scenario assumes that after October 31 the UK becomes a “third country” to the EU bloc. In other words, unless Britain quickly secures new trade deals with European Union countries, there might be long-term obstacles like high import taxes for British goods selling to what is the world’s largest single trading area.
The eye-watering reality is that the EU is currently the UK’s largest trading partner, accounting for 46% of all exports in 2018. The risk of losing the whole or part of this amount of trade overnight is likely to have an enormous impact on the British economy and is an incentive for finding compromises.
Could the GCC come to the aid of the post-Brexit UK?
The British economy would have to adapt rapidly, perhaps by building closer relations with economies in the Gulf Cooperation Council (GCC). With diminished prospects in the EU, there might be a flight of British capital and job seekers to the GCC which has traditionally close strategic and trading relations with the UK. The two markets already have considerable trade amounting to £17.5 billion (2017) and rising. Earlier this year the UK approached the GCC to negotiate a post-Brexit free-trade deal, although such a deal is contingent on Brexit’s final outcome
Already, the UK is seeing considerable investment from Emirati banks which pumped 61 AED billion into investments in the first quarter. In addition, the UK has positioned itself to invest in healthcare and infrastructural projects in the GCC. The largest industry in the UK’s manufacturing sector – food and beverage – is seeking new export opportunities in the GCC and the UAE is already the second-largest international buyer of British breakfast cereals. According to a UN report, among the GCC states, the UAE would see the biggest benefit from a no-deal Brexit with $425 million in additional annual profits from exports to the UK, followed by Saudi Arabia with $267 million.
Yet, such potential gains for the GCC can only be materialised once there’s absolute clarity on Brexit’s fate. In the interim, investors will be closely monitoring whether PM Johnson will “walk the talk” in trying to lead the UK out of this Brexit fog.
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