UK market, currency rally on optimism that vaccines will return economy to normality

London

FOREIGN exchange and equity market participants appear to be in denial about an over-borrowed UK economy that is experiencing the worst depression in three centuries.

Since the start of November, vaccination optimism has caused the FTSE100 index to jump by 17 per cent. The pound has also defied the currency bears and has rallied by 4 per cent against the US dollar.

Following the steep stock market rally, several investment banks and economists expect blue skies ahead on expectations that swift distribution of vaccinations will boost confidence and return Britain to normality.

As at press time on Sunday night, a Brexit trade deal with the European Union still has not been agreed on. But the rise in the pound illustrates that the market is confident that there will eventually be some sort of accord.

The Bank of America's European analysts predict that the FTSE 100 index will rise a further 16 per cent from 6,412 to 7,400 by the middle of 2021.

Paul Dales, an economist at Capital Economics, contends that the vaccines are a "game-changer".

Following a downturn of 3.5 per cent in the fourth quarter, the economy will return to its pre-Covid crisis levels in the first quarter of 2022, he said. Monetary policy will "remain ultra-loose" with large-scale quantitative easing continuing.

"As long as the politicians don't mess it up, the outlook for mid-2021 is better than most people think," he said, adding that the risks are either a no-deal Brexit or having a bad deal with tax increases.

The Centre for Economic and Business Research (CEBR) and other consultants are more cautious.

According to estimates by the CEBR, British Prime Minister Boris Johnson's decision to impose tougher tiers of restrictions on some 23 million people in the Midlands, the north-east and north-west of the country could cut the UK's gross domestic product (GDP) by 13 per cent, or a staggering £900 million (S$1.6 billion) a day.

There are already sizeable business losses and rising business failures.

One of them is Arcadia, a retail clothing group selling Topshop, Burton and Miss Selfridge brands. The company is hovering on the brink of collapse.

If it cannot be rescued, 15,000 direct jobs and an estimated 15,000 others working for suppliers are on the line, said retail analysts.

West End and other landlords that rent to Arcadia would also be hurt. This illustrates that the UK is sliding towards forecast unemployment of 7.5 per cent or 2.6 million workers, double the levels of 2019.

Since Covid-19 hit the British economic and social fabric, Chancellor of the Exchequer Rishi Sunak has borrowed £394 billion to keep people and businesses afloat.

These government bailouts have made Mr Sunak more popular than Mr Johnson, leading some commentators to predict that it is only a matter of time before Mr Sunak takes over as the next prime minister.

The big question is whether Mr Sunak's popularity will last. He has warned that the UK sovereign debt, which is heading towards £2.8 trillion or 130 per cent of GDP, is unsustainable.

There will have to be tax increases and public sector wage freeze "takeaways" next year, he has indicated. Moreover, demand could be slack if it is difficult to get rid of the virus.

In the meantime, the big question is whether the pound will maintain its current levels.

The UK Office of Budget Responsibility forecasts that the annual budget deficit will be equal to 19 per cent of GDP, double the previous peacetime record.

It expects an additional £450 billion in "asset purchases" by the Bank of England. The flood of money, along with zero or even negative interest rates, could discourage international investors from holding pounds.