Last week, Deutsche Bank’s research team argued that the UK was at risk of an old-fashioned balance of payments crisis, due to its dire economic dynamics. Barclays has now waded into the debate, calling it a “crisis fairy tale”.
Our premise is quite simple: there is no great British history here yet. The shock is global and therefore the EUR and GBP should trade relatively in line. Europe and the UK are proportionally affected by the same external shock – a massive spike in energy prices that significantly 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 firms to produce internally or to trade externally.
To support its argument, Barclays uses this graph showing the weakening of the German current account in line with that of the United Kingdom, to underline what a symmetric shock on the terms of trade.
Of course, eagle-eyed readers will quickly spot the rather heinous crime of the two-axis chart, with Germany‘s current account surplus still massive. Perhaps there is an element of Barclays rushing to defend its internal market here.
However, we are inclined to agree that what will matter most for currency markets is the stance of their respective central banks, and the Bank of England should be much more hawkish than the European Central Bank. If the BoE raises rates much more aggressively – which seems likely – then the pound’s recent weakness against the euro should fade, argues Barclays.
However, Barclays analysts point to another major danger lurking.
For us, the real risk of an idiosyncratic shock to the pound lies elsewhere. While there are no such early signals, the new administration’s stance on EU relations carries the clear risk of triggering Article 16 of the Northern Ireland Protocol. The EU could, in this case, retaliate by imposing customs duties on British imports or by suspending the trade and cooperation agreement. Going back to WTO rules could mean a 4-5% depreciation of the pound against the euro.