Brexit: how will the pound perform in 2021?

As hard as it is to believe, Brexit does not hold the record when it comes to prolonged processes. Take the Basílica de la Sagrada Família in Spain for example: work began on the world-famous church in 1882 and it is still not finished. The Brexit free trade deal was achieved in a relative blink of an eye compared to the construction of Barcelona’s most popular tourist attraction – but it did not feel like it. The 1,646 days that elapsed between the EU referendum in June 2016 and the deal finally being struck on Christmas Eve felt like an eternity for the UK economy – and the pound, which has been constantly buffeted by concerns over the UK’s withdrawal from the EU.

Short-term impact on the pound

The short-term impact of the deal – that will define the UK and EU’s relationship for decades to come – on the pound was unsurprisingly positive. The UK economy got an immediate jolt of confidence after both sides got the agreement over the line at the eleventh hour. Less than a week later, UK parliament’s swift approval caused markets to breathe a sigh of relief that the UK economy had avoided a no-deal cliff edge. The pound subsequently surged in value, breaking through the 1.37 barrier against the dollar for the first time since 2018 and rising to its highest level against the euro since early September.

With the ink still drying on the 2,000-plus page agreement, it is time to ask: how will the deal impact the pound in the coming months? A question that will play out against the backdrop of another significant – and as yet unresolved – factor: the Covid-19 pandemic.

Long-term forecast for the pound

Big political announcements can have significant impacts on currency valuations over time, and the Brexit free trade agreement between the UK and EU – which took effect from 1 January – is no different. Even with a deal secured, enabling the pound to start the new year on the front foot, analysts have been quick to caution that it could face a period of volatility, as markets adjust to the new economic relationship. This crucial process of examining the deal to understand all the details has already unearthed some initial concerns over a lack of clarity on the services sector – most notably the crucial banking and financial industries.

While the free trade pact helps both parties avoid potentially crippling tariffs, the UK could still face economic costs from residing outside the EU. The friction of cross-border transactions – which now require customs checks and new documentation – could hold back an economy already under pressure from strict lockdowns to curb the Covid-19 pandemic. For example, Citigroup estimate that Brexit-related disruptions could curtail British economic activity by two per cent in 2021 – a development that would weigh on the pound.

However, as pandemic panic ramps back up amid a surge in infections caused by a more contagious strain of Covid-19, there is hope for the economy – and the pound – on the horizon. Yes, the announcement of a third national lockdown sent jitters through the economy, but the approval of AstraZeneca’s game-changing vaccine is fuelling hopes of a major economic recovery in the UK this year. All eyes are now on the effectiveness of the vaccine rollout, which could drive sentiment towards the pound in the coming weeks and months.

Looking even further ahead, the pound could eventually find support from the free trade deal’s ability to limit some of the damage of leaving the single market and customs union – after all, a deal is better than no deal. By removing a major downside risk to the economy, the deal has the potential to unlock significant investment in the UK and underpin the recovery once the ongoing Covid-19 shock starts to dissipate – further highlighting the economic importance of the vaccination process.

Currency markets are unpredictable

The two variables that will dictate the pound’s course in 2021 – the UK’s new relationship with the EU and the fight against the Covid-19 pandemic – are not only unpredictable they are also unprecedented – taking the UK economy and its currency into uncharted waters.

From new PMs and endless negotiations to fresh lockdowns and financial bailouts, the pound has learnt the hard way that nothing is certain when it comes to Brexit and the pandemic. Time will tell if the free trade deal will be “the basis of a happy and successful and stable partnership” – as claimed by Boris Johnson upon announcing the accord – and if the latest lockdown restrictions and vaccine rollout can support an economic bounce back.