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The UK economy has weathered the 12 months since the vote to leave the EU better than feared, though the 1Q gain in GDP was, at 0.1% qoq, the slowest in the EU and the uncertainty emanating from the 8 June election result won’t help going forwards. The UK has the same annual growth rate as the US (2%) and is marginally above the euro area’s 1.9%. From here, we think there will be divergence, with the UK falling to the bottom of the pile – 1.6% growth in 2017, compared with 2.1% in the US and 1.8% in the euro area; and 0.9% in 2018, compared with 2.2% in the US and 1.5% in the euro area. Some of that is ‘in the price’, but not all.
We don’t want to rely too much on our own longer-term forecasts, but there are two key points that affect the outlook for the currency. The first is that the story of relative growth trends is one of the euro area catching up with the US and UK, which is why the ECB is edging closer to normalising its monetary policy. And the second is that however negative the economic effects of Brexit prove to be (we think it will be corrosive, rather than a short sharp shock), they are a UK-specific drag on growth, which will keep UK monetary policy more accommodative and weigh on the pound, particularly against the euro.
One piece of good news is that the UK balance of payments has improved sharply thanks to a big improvement in the primary income balance, which captures earnings from foreign investment. A weak pound and higher commodity prices have done their thing. It’s just a pity that Brexit threatens the huge services surplus much more than a weak currency helps the even bigger goods deficit. Still, a current account deficit of 2-3% GDP in the coming years should not be a huge factor for the currency.
Long 1y GBPUSD 1.27 put vs 1.3230 call (25D risk reversal).
Short GBPCAD via 2m AED dual digital USDCAD<1.30, GBPUSD < 1.2090.
