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On 24 December, UK and EU negotiators reached an agreement on a trade deal, keeping the GBP elevated. Beyond the deal, economists at HSBC struggle to see how the UK will retain its competitiveness compared to its current position. Considering also the challenging cyclical growth outlook, the pound is set to be a G10 FX underperformer. 

Key quotes

“Although the rally in the GBP in 2020 suggests the FX market anticipated that a deal was more likely than not, confirmation allows the FX market to price out whatever modest probability had been attached to a ‘no-deal’ outcome. In our view, the announcement should keep the GBP elevated over the near-term, but further upside will likely be limited, given the agreement looks largely priced in.”

“Inevitably the EU will remain the biggest trading partner for the UK, given its geographical proximity. The increased barriers to trade with the EU are highly unlikely to be offset significantly enough by any potential declines in barriers elsewhere, especially if the UK-US trade deal is potentially pushed further into the future. A weaker trade-weighted GBP would be one way to offset those costs.”

“We have seen suggestions in some quarters that the downside growth impact of Brexit will not matter as much, given the strong and likely volatile rebound from pandemic-related weakness that will be occurring simultaneously. But our view is that any additional downside to growth would make the GBP look relatively less attractive when its peers are recovering at even faster rates.”

“Despite a solid performance versus the USD in 2020, the GBP has broadly underperformed its G10 peers. We believe underperformance is justified and is likely to continue in 2021. We see GBP-USD trading broadly sideways in 2021.”