BNY Mellon: The Bigger Picture

February 12, 2019

By Simon Derrick, Chief Currency Strategist

• Downward pressures on housing market, growth in longer-dated yields and GBP date back to 2014
• Coincide with meaningful shift in UK property taxes
• An emerging suspicion that Brexit process has simply exacerbated existing trends

 With 45 days left before the UK formally leaves the EU there appears little sign of a breakthrough in the EU/UK negotiations or a majority in favor of any course of action within the UK Parliament (though there have been some small signs of movement).

There also seems to be little evidence of nations rushing to negotiate new trade deals with the UK at present.

Unsurprisingly, the failure to make material progress in recent months has taken its toll on the UK economy. While the preliminary reading of Q4 GDP data (1.3% y/y) conformed with the broad expectations, the sharpest hit to growth in the quarter came in December just as unrest in Parliament became particularly apparent.

It’s important to note, however, that the slowdown in growth in the UK is part of a trend that predates the EU referendum by two years, first emerging around the time of a meaningful change to levels of stamp duty in the UK (see chart above).

This, in turn, is part of a broader pattern that stretches back to early 1988 just as a housing market bubble in the UK was nearing its peak.

Given this, it’s worth observing that a number of housing indicators have also been trending lower since the summer of 2014 rather than simply since the EU referendum.

The Royal Institution of Chartered Surveyors’ house price balance has been declining since then (with the pace of the slowdown accelerating in Q4) as have both the Nationwide and the Halifax house price surveys.

This slowdown has also coincided with marked pick up in the pace of the downward trend in longer-dated yields that’s been in place since the bursting of the 1980s housing bubble (feeding directly into the nine-year-old pattern of yield curve flattening seen in the UK).

These moves have in turn been matched by downward pressure on GBP since the summer of 2014 (when it peaked out above USD 1.72). The summer of 2014 also saw some of the lowest levels of implied volatility in GBP/USD since the summer of 2007.  

Why does this matter right now? There has, understandably enough, been a huge focus on the outcome of the Brexit negotiations. However, there is the suspicion that the main impact so far of the uncertainty created by Brexit has been to exacerbate trends within the UK economy that were likely already there.

Certainly the slowdown in growth and the housing market, bringing downward pressure to bear on UK yields and GBP (see chart below) can be seen to date back half a decade (and, arguably, thirty years). 

This suggests that while it's highly likely there would be a bounce in GBP should the Brexit negotiations result in a business/investment-friendly outcome, this might prove weaker than imagined.

It also suggests that the emerging weakness seen in longer-dated UK yields might be the real warning signal for the outlook for the currency.