The British pound climbed as high as $1.411 on Monday, its strongest level since February, as the UK economy is on track to return to pre-pandemic levels by the end of 2022.
Sterling's rise came amid a sharp drop in Covid-19 deaths and cases in the UK, however the country’s poor coronavirus performance will leave it with permanent scarring compared to other major economies, the National Institute of Economic and Social Research said.
The think tank expects growth domestic product to increase 5.7 per cent this year, higher than its earlier expectation of 3.4 per cent, with growth of 4.5 per cent in 2022 taking the economy to its pre-crisis levels by the end of next year.
However, NIESR said growth will be "brisk but not better", with unemployment set to rise to 6.5 per cent when government support programmes taper off later this year, while over the long term the full effects of the massive drop in GDP at the start of the pandemic are yet to hit home.
“GDP is expected to be around 4 per cent lower than its pre-pandemic level by 2025. This amounts to a total of about over £700 billion ($978.84bn),” Hande Kucuk, deputy director for macroeconomics at NIESR, said on Monday.
“These long-term effects are partly driven by the initial size of the contraction, which was quite large for the UK compared to other advanced economies, but is also partly because the UK had a higher prevalence of the virus. This implies that the UK will have permanent costs after the pandemic compared to advanced economies such as the US and Germany.”
The Bank of England is more optimistic about the strength of the UK economy going forward, last week predicting 7.25 per cent growth this year. That prediction was much faster than the 5 per cent initially forecast by the central bank three months ago.
However, the lender lowered its projection for growth in 2022 to 5.75 per cent from its previous estimate of 7.25 per cent.
As well as higher unemployment, with about 450,000 of those still on furlough in September expected to lose their jobs when the scheme ends, NIESR expects the effects of Covid-19 and Brexit to lead to large regional variations across the country.
Destitution is set to rise in all three of the UK's devolved nations of Wales, Scotland and Northern Ireland, as well as in northern England and the south-east, with high child food poverty among single-parent households also increasing, NIESR said.
So far, the UK has suffered the highest death rate from Covid-19 in Europe, and the fifth highest globally, with more than 127,000 deaths since the start of the pandemic.
The UK's 9.8 per cent fall in GDP last year was the largest in the G7, with the majority of this attributable to the greater prevalence of the disease in the UK and the country's relatively unprepared health system, NIESR said.
The pound surged above the $1.40 mark on Monday, fuelled by a weaker dollar, improved economic outlook and market relief that a Scottish independence referendum looks unlikely in the near term.
Pro-independence parties won a majority in Scotland's parliament on Saturday, paving the way for a high-stakes political, legal and constitutional battle with British Prime Minister Boris Johnson over the future of the UK.
But the pound strengthened as market participants did not interpret this as a near-term risk and welcomed Scottish leader Nicola Sturgeon's decision to prioritise the Covid-19 pandemic over independence.
“Sterling has been boosted by optimism over the UK economy amid the big drop in Covid cases and deaths thanks to the lockdowns and vaccination success, with investors also ignoring the prospects for a second Scottish independence referendum,” said Fawad Razaqzada, market analyst at ThinkMarkets.
NIESR's expectations for faster GDP growth are driven by the UK having one of the fastest vaccination programmes in the developed world, with the immediate effects of the virus, which have largely hit those on low incomes, expected to wane.
However, the think tank said neither the pandemic or Covid-related uncertainty are over with the UK’s open economy leaving it vulnerable to the escalating number of crises in other parts of the world, such as in India.
“The UK will not be physically or economically protected from a failure to control the virus globally,” NIESR said.
The think tank also called for greater clarity on monetary and fiscal policy going forward, which have become increasingly interlinked during the pandemic, when government debt rose sharply and interest rates dropped to record lows.
“Given the increased intertwining of monetary and fiscal policy as a result of quantitative easing, greater clarity is urgently needed about the way that tightening will be conducted when required and how HM Treasury will deal with any potential interest rate volatility,” NIESR said.