Since the UK referendum to leave the EU, the exchange rate of the pound has been a sensitive measure reflecting market mood related to Brexit. The general pattern so far has been that at times when there has been less clarity from the UK government regarding its next steps, or whenever the outcome of a ‘hard Brexit’ has become more plausible, the pound has lost value versus the euro and versus the US dollar. When the opposite has been the case, the pound has generally gained value compared to the euro or the US dollar.
Recently, the value of the pound has increased versus the euro as the UK government’s plan for Brexit has been made more clear (see the political section regarding the prime minister’s speech outlining the government’s Brexit strategy). Additionally, the publication of positive economic indicators, such as stronger than expected UK economic growth in the fourth quarter of 2016 and the increase in manufacturing orders for January this year, have contributed to a higher value of the pound compared to the euro. The assumption that the Bank of England may raise interest rates this year, if inflation continues to rise, played a role as well in the appreciation of the pound. Dovish comments from the Bank of England (BoE) at the beginning of February, led however to small drop in the pound, as it became clear the BoE may actually temporarily accept a considerable higher inflation than 2%.
Developments in the value of the pound versus euro
UK-Eurozone trade, January 2014 to November 2016, in billion pounds
Regardless of the recent upturn, the pound has lost approximately 11 percent of its value in comparison to the euro since the referendum outcome in June. This obviously means that products and services priced in euro, have -all else being equal- become more expensive in the past months. Did this lead to a reduction in exports from the Eurozone to the UK?
Monthly data from the UK HM Revenue & Customs shows that the value of imports from the Eurozone increased since June 2016. This increase roughly matches the increase in value of the euro versus the pound. The value of exports to the Eurozone also increased. In November 2016, the value of goods shipped to the Eurozone was more than 15% higher than in June of the same year. It is too early to draw conclusions, but preliminary indications point to an increase of exports from the UK to the Eurozone. Nonetheless, the trade gap has not closed. The UK still imports far more from the Eurozone than it exports to this group of countries.
If we take a look at UK trade more broadly (see graph below), we see that that the total amount of exports increased from August 2016, while the total amount of imports into the UK did not show a significant upturn since June 2016. The share of the Eurozone in both UK total export import hardly changed in the months following June 2016. The future will tell whether the Eurozone can protect its share of roughly 43% of total imports into the UK, versus other trading partners post Brexit.
UK foreign trade, November 2015 to November 2016, in billion pounds
The new year has provided somewhat more clarity on the Brexit process. On the UK side, few people will have missed prime Minister Theresa May’s speech in which she outlined the UK government’s priorities for the Brexit negotiations, and the Supreme Court’s decision that the UK government must enact a bill in parliament before it can trigger Article 50. In her speech, the Prime Minister said the UK would not seek to remain a member of the Single Market, but that it would want to discuss a ‘bespoke’ customs union with the EU, and that it would walk away from the table with no deal if an arrangement which would be satisfactory for the UK could not be reached. As for the Supreme Court ruling, a bill that will enable the Article 50 notification was swiftly published already the following day, and was subsequently accepted by parliament with an overwhelming majority. While the end of March deadline for triggering article 50 is not included in the article 50 bill, both events set a rather rapid pace. With Parliamentary elections in the UK in May 2020, it would seem to be in the government’s interest to have settled the UK’s departure from the EU by then.
On the other side of the English Channel it is less clear how the UK’s relatively tough stance might land with the European partners, once the Brexit negotiations begin. A few comments in the days following Theresa May’s speech give an indication. Even member states which have traditionally been close allies with the UK, expressed concern that what the UK government has proposed is simply too much and unrealistic, and that negotiations run the risk of coming to a crash landing.
Additionally, Europe has many moving parts. Elections in France, the Netherlands and Germany this year being some of them. In France a centrist pro-European president Emmanuel Macron, a return to traditional left-wing policies under a presidency of socialist Benoit Hamon, or a victory by right-wing populist Marine Le Pen, may mean a very different interlocutor in the EU for the UK. Furthermore, we continue to stress that any final Brexit deal will need to be approved by a majority of EU27 member states in order to take effect. The political risks of a very ‘hard Brexit’ are therefore plenty and businesses should prepare accordingly, assuming that the UK will not be in the Single Market or have preferential access to EU markets after 2019.