EU negotiations, GBPUSD and Current Account
The tough line on immigration suggests that the upcoming EU divorce negotiations may reduce the chance of the UK maintaining EU market access (our economists today increased probabilities of a hard Brexit to 70%). Notably, the EU’s own problems have made the UK’s position more difficult. The Sunday Telegraph wrote that some of the UK’s largest “companies are being frozen out of crucial discussions in Brussels, sparking fears their international operations could face swift ‘policy punishment”’. A new tone has swept across the EU. Not so long ago it was suggested the UK could maintain the EU as its best partner after Brexit. Now, German chancellor Merkel has warned German business leaders not to waste time lobbying on behalf of the UK. The EU is now focused on internal stability and a soft EU deal with the UK is viewed as threatening this stability. With the UK putting passport and border control above other negotiation targets such as maintaining free market assess has introduced investmentuncertainty into the UK’s business sector.
It has been the business unfriendly rhetoric at the Birmingham Tory Party conference alarming investors with David Cameron’s previous adviser Steve Hilton seeing the risk of PM May turning towards a ‘closed’ opposed to an ‘open Brexit’. Hilton had been campaigning for Britain to leave the EU with the vision of turning the UK towards a centre of free trade, swimming free from EU regulation. Instead, some of PM May’s proposals may have the effect of impos[ng additional hurdles for the UK’s corporate sector such as possibly recording the number of foreign employees working for a company. Hilton suggested that the Brexithe was aiming for was not to control the number but the quality of immigration. Increasing the quality of immigration increases the growth potential of an economy. Reducing the size of immigration weakens the growth potential the economy.
When there is a substantial 6% current account deficit as currently seen in the UK then it will be the return of UK investment deciding the structure of funding flows and the way to consolidate the foreign imbalances. A strong supply side offering high returns and thus competitive investment opportunities suggests supportive FDI and long-term investment inflows promising stable foreign funding conditions. Additionally, a strong supply side will improve the trade outlook promising a smooth adjustment of the CA deficit. Weakening the supply side when there is a high foreign imbalance provides the culprit for a more violent adjustment. Last week saw GBP trade like an EM currency. Credit spreads widened, domestically focused shares fell, sovereign yields rose as GBP moved lower. We reiterate, for the GBP outlook what matters is the supply side of the UK economy and anything we have learnt last week undermined our confidence in the UK aiming for a smooth adjustment. PM May is travelling to Denmark and the Netherlands on Monday for talks with Prime Ministers Lars Lokke Rasmussen and Mark Rutte respectively. These talks are unlikely to produce GBP supportive comments.