Last week Deutsche Bank’s research team argued that the UK was in danger of suffering an old-school balance of payments crisis, due to its woeful economic dynamics. Barclays has now waded into the debate, calling this a “crisis fairytale”.
Our postulation is fairly straightforward: there is no big UK story here yet. The shock is global and thus, EUR and GBP should trade fairly in line. Europe and the UK are being proportionately hit by the same external shock — a massive energy price spike that substantially deteriorates their terms of trade. In its true essence, a commodity terms of trade shock has two major effects: 1) it transfers income from the commodity consumer to the commodity producer; and 2) it increases the cost structure of an economy, eroding the competitiveness of its companies to produce internally or to trade externally.
To back its argument, Barclays uses this chart showing the German current account weakening in line with the UK’s, to underline how this is a symmetric terms of trade shock.
Of course, eagle-eyed readers will spot the pretty heinous dual-axis chart crime quickly, with Germany’s current account surplus still massive. Perhaps there is an element of Barclays just rushing to the defence of its domestic market here.
However, we’re inclined to agree that what will mostly matter for currency markets is the stance of their respective central banks, and the Bank of England is expected to be far more hawkish than the European Central Bank. If the BoE does jack up rates much more aggressively — which seems likely — then sterling’s recent weakness versus the euro is likely to fade, Barclays argues.
However, Barclays analysts DO highlight another major danger lurking.
To us, the real risk of an idiosyncratic GBP shock lies elsewhere. Although there are no early signals of this nature, the new administration’s stance on EU relationships carries the clear risk of a triggering of Article 16 of the Northern Ireland Protocol. The EU could, in this case, retaliate by imposing tariffs on UK imports or suspending the Trade and Cooperation Agreement. Falling back to WTO rules could mean a 4-5% GBP depreciation against the EUR.
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