In this context, the Bank of England can only step up its stimulus effort to avoid a liquidity squeeze that will inevitably disrupt its economy further. The central bank knows it perfectly well; this is why the BOE is preparing national banks that they might see negative interest rates soon. Banks are pushing back on the idea of negative rates. Still, the central bank might not have any other option rather than proceeding with this policy tool and expand its Quantitative Easing (Q.E.) program.
Gilts: safe-heaven in the short term might become the new periphery in the long term
The real question here is whether gilts will continue to be perceived as a safe heaven amid an increase of Covid-19 cases and a hard Brexit. The answer is not easy because, on one side, BOE's accommodative policies will push gilts prices higher. On the other hand, without the support of the E.U., and a deep economic recession, gilts may become riskier than the periphery.
There is one loophole though: the country has its own currency. In this context sterling capital seeking protection will not have other choices rather than buying gilts. This is why we believe that a hard Brexit together with a dovish BOE, and a new wave of Covid-19 cases will push gilts prices higher in the mid-term, flattening the yield curve further.
So far, gilts offered a natural shelter to sterling investors. The graph below shows how gilts performed compared to the U.K. stock market from the beginning of the year until now. While the FTSE 100 continues to suffers from outflows amid Brexit, the Covid-19 and the recession, gilts are benefitting from it.
In conclusion, regardless of which type of Brexit is going to be agreed, gilts will prove to be essential for capital preservation during the next 5- to 6-months.
In the long run, the recession will continue to weight on the British economy much more than any agreement that the country will make. Within this context, the U.K. will not benefit from the European Union's safety net, and the BOE will be entirely alone trying to bail out a zombie economy.
Hence, gilts are running the risk to become the new periphery.
Until that moment, we will continue to see Boris Johnson, and his wild hair, trying to put patches on a sinking ship. At this point, the most sensible thing for Mr Johnson to do is to buy himself a good comb and spare us with this torture.