Interest rates could go negative and Brexit is hitting the pound again too

Why is the pound slipping? Bond investors pay to lend the Government money and interest rates could go negative with Brexit hitting sterling again too

  • In March, pound sterling hit its lowest level against the dollar in thirty-five years
  • The government has repeatedly said there will be no extension to the Brexit talks
  • The strength of a country’s currency and its rate of interest tends to be inverse 

By Harry Wise For This Is Money

Published: | Updated:

The Bank of England issued negative-yield bonds for the first time in its history this week. This means that investors are paying the Government to lend it money – on the basis that it’s safer there than anywhere else.

It follows the slashing of interest rates to a record low of 0.1 per cent and hundreds of billions in Bank of England stimulus and fiscal measures to mitigate the fallout from the coronavirus pandemic.

The Bank of England’s chief economist Andy Haldane has explicitly not ruled out interest rates dropping into minus territory.

The pound hit its lowest worth in almost eight weeks of $1.21 on Monday

‘The economy is weaker than a year ago, and we are now at the effective lower bound, so in that sense, it’s something we’ll need to look at – are looking at – with somewhat greater immediacy,’ he remarked in an interview this week.

His comments will not have helped a shaky sterling. The pound this week slid to $1.22 and €1.11 against the UK’s main trading partners – its lowest levels in almost eight weeks. 

That’s well off the lows hit at the height of the coronavirus panic in mid-March, when it dropped to $1.15 and €1.06. But it had until recently returned to more steady rates of $1.25 and €1.15.

What those March lows suggest is that in terms of a safe-haven currency, the pound is very much third behind the dollar and euro, and even fourth behind the yen. 

And the dollar trumps all its three main global forex counterparts as the currency that global investors have ultimate faith in, in times of crisis. 

So whether negative UK interest rates would send sterling even lower than its mid-March nadir is debatable. But as a general rule, the strength of a nation’s currency and its benchmark rate of interest tends to have an inverse relationship.

This is because investors tend to be more willing to deposit their cash in places where they can receive a higher return on short-term interest rates. 

The gradual loosening of lockdown restrictions in recent weeks in Europe has meant more businesses have been able to restart and this has buoyed investor confidence in the euro. By contrast, the UK has been relatively sluggish in its approach to exiting the lockdown.

On Friday, the third round of Brexit talks between the UK and the EU ended with, the UK’s chief negotiator David Frost (left) stating there had been ‘very little progress towards agreement on the most significant outstanding issues between us’

However, the growing threat of a no trade deal with the EU is also now hitting investors’ confidence in the pound. Behind the curtain of coronavirus, relations between the UK and the EU have become increasingly fractious and this is creating uncertainty for the future of the British economy.

This was compounded last Friday when the third round of Brexit talks between the UK and the EU ended. The UK’s chief negotiator David Frost stated there had been ‘very little progress towards agreement on the most significant outstanding issues between us.’

The pound fell against the euro as a result. But headlines on these negotiations have played second fiddle to the coronavirus pandemic in the headlines in the last two months. 

Viraj Patel, Arkera: ‘Talk of negative rates in the UK…as well as the renewed threat of a ‘No Deal’ Brexit once the transition period ends this year – are materially weighing on the pound’

Despite calls to extend the transition period for an extra two years, Prime Minister Boris Johnson’s government has repeatedly insisted that talks will not be prolonged.

If Johnson forgoes any further extension, which he must ask for by June 30, then the UK and EU will only have six months left to strike a very complicated free trade accord.

Investors are therefore beginning to get increasingly nervous that no trade deal will be agreed. Should it turn out like that and the coronavirus pandemic aggressively persists, this could potentially cause an even more acute amount of problems for the UK and EU economies.

A no-deal exit could potentially magnify trade problems between the UK and its continental neighbours, scare off financial investors and consequently make the UK a worse place to put your money, thereby causing the pound to fall further.  

‘We’ve seen sentiment around sterling flip from positive to negative in recent weeks as investors shift focus to local idiosyncratic risks,’ said Viraj Patel, an FX and global macro strategist at market intelligence firm Arkera.

‘Talk of negative rates in the UK (with markets slowly pricing in this reality) – as well as the renewed threat of a ‘No Deal’ Brexit once the transition period ends this year – are materially weighing on the pound.’

To deal with one once-in-a-generation issue is challenging enough, but to try and manage two is even worse. One significant wrong move could be dreadful for the pound, for investors and the British economy.

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