Although the withdrawal of the United Kingdom from the European Union formally occurred on January 31st, 2020, the country is currently in a transitional period in which few economic changes have occurred. During this period, which will last through 2020, the UK is still a participant in the EU's customs union and common market arrangements. The question for Forex traders, though, is what will happen when this temporary arrangement expires in 2021. Here's what you need to know about the effects Brexit may have on the GBP.
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The major factor which will determine how Brexit will impact the British pound is whether or not the UK and EU can reach a suitable trade deal before the transitional period expires at the end of 2020. Without a free trade arrangement in place with the EU, the United Kingdom would lose access to the common market, inflicting new costs on both businesses and consumers in the form of trade barriers. Various banks and investment funds have predicted a wide range of probabilities for a no-deal Brexit, with likelihoods being estimated at anywhere from 20 percent to 60 percent.
Absent a trade deal, the outlook for the GBP is generally bearish. By some estimates, a no-deal withdrawal could reduce the value of the pound by 10 percent against the dollar. The argument for a long position on the EUR/GBP pair is relatively strong without a trade deal, especially in light of mounting evidence that the downturn associated with the COVID-19 pandemic will be both longer and deeper than initially predicted. Existing debt to GDP ratios reinforce the potential wisdom of this strategy, as both the UK and EU will likely have to run up their current debt loads in order to stimulate their respective economies. Currently, the UK carries 100.9 percent of its GDP in debt, while the 27 remaining EU nations carry only 77.8 percent overall.
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Although debt and the effects of the COVID-19 pandemic remain concerning, the outlook for the GBP is considerably more positive if a trade deal is reached before the end of 2020. Optimism over trade negotiations has already buoyed the short-term outlook for the pound, with CitiBank identifying a buying opportunity in the GBP/USD pair at 1.2438. According to the bank's analysts, bullishness on the possibility of a trade deal could carry the pound to 1.27 against the dollar on a 3-month time horizon. The same positive effects of a finalized trade deal would also play out in the longer term. If a deal is reached, analysts expect the pound to move 4 percent higher against the dollar and remain largely stable against the euro over the next 12 months. Provided a suitable trade deal comes through, the upward motion of the pound against the dollar is expected to begin toward the end of 2020.
Overall, Brexit's effects on the GBP will largely come down to the success or failure of a trade agreement between London and Brussels. Because of the uncertainty presented by the negotiations, there are potential opportunities for Forex traders in both long and short positions. When combining the effects of Brexit with other relevant factors in the pound's strength, however, a long EUR/GBP position may be the safest avenue.