Brexit: Analyst Issues a Dire Warning for the British Pound

BrexitBritish Pound Has Uncertain Future

The Swiss investment bank UBS warns that a Brexit would see the British pound (GBP) trade at parity with the euro. (Source: “Brexit would drive pound down to parity with euro, warns UBS – as it happened,” The Guardian, February 29, 2016.)

That marks a big drop. The pound sterling dropped to US$1.39 as of March 1—its weakest level since March 2009. (Source: Ibid.) At its current level, the GBP trades at 1.27 euros—or, if you prefer, 78 pence buys one euro.

While the threat of a weaker pound could help some U.K. export groups, it would make travel and working in Europe much more expensive.

Trading in recent weeks has reminded us of the increasingly difficult relations between the United Kingdom and the rest of Europe. UBS analysts said that there is a 40% chance that the British people would vote in favor of a divorce from the European Union (EU).

Yet, a Brexit would be a problem both for the U.K. and for Europe. The GBP has dropped to new lows since Britain set June 23 as the date for the referendum over its EU membership. The pound sterling hit an almost seven-year low against the euro as the EU referendum campaign has tarnished the GBP’s appeal among investors.

The Bretton Woods agreements changed the fortunes of the British pound. They formally saw the U.S. dollar replacing the pound sterling as the global reserve currency of choice. The decline of the pound, which began with the fall of the gold standard in the First World War and the 1930s, is irreversible. Ironically, it is to save the pound that the United Kingdom joined the EU’s precursor, the European Economic Community (EEC), in 1973.

This was after the collapse of Bretton Woods itself and the gold standard. These episodes caused wild economic and currency fluctuations. Britain found the prospect of a common European market as a buttress against the instability of fiat currencies attractive.

Over the years, however, the British economy has shifted in favor of financial services and away from industry. One of the goals was to elevate London as the financial center of Europe and the world. The U.K.’s imperial legacy has favored its transition to a global hub, making it less vulnerable to the siren song of European integration, which seduced so many states in the continent. The United Kingdom does not use the euro, it does not participate in the Schengen area, and it maintains separate security policies.

Certainly, British citizens would have to show their passports again at non-EU lineups when they travel to their favorite holiday destinations, France or Spain. They would also have to renegotiate access to the European market, which many British companies still enjoy. Moreover, they would need to renegotiate hundreds of deals and agreements with as many countries and blocs of countries signed by the European Union.

In the transition phase, unlike after Bretton Woods, there are few lifeboats for the British pound. One of the likely effects of the potential Brexit is increased capital flight. British multinationals may prefer parking their savings in countries such as Ireland and Luxembourg to benefit from the EU internal market.

The British economy itself risks collapse. Scotland would most likely ask to leave the United Kingdom and to remain in the European Union, while London would lose its status as a global financial center and a crossroads of capital across the world.

Simply put, the British pound could collapse.