The Brexit Could Hammer the British Pound
If ever politics, finance, and literature meshed into one big multidisciplinary dilemma, the Brexit referendum would fit nicely. Shakespeare and Hamlet come to mind, but as Britain decides to stay in or leave the European Union (EU), The Clash’s “Should I Stay or Should I Go” also works.
The British pound (GBP) remains the protagonist in the currency markets, whichever outcome emerges from the June 23 referendum—either Brexit (leave) or Bremain (stay). Indeed, all eyes are on the pound as the GBP to USD exchange rate continues to move in favor of the dollar.
On June 13, less than two weeks before Britons vote on the country’s EU membership, the GBP to USD exchange rate was trading at 1.42—its lowest point in months. Indeed, the pound’s very relationship with the dollar (the pair is called “the cable”) should worry those with long positions on the British currency. When the pound crossed the 1.42 mark last Friday, it caused no amount of bullish British pound investors to lose sleep.
The breach of the 1.42 mark violated the bullish trend line that was, at the very least, offering some stability in the GBP to USD exchange rate since last March. The British pound has faced strong pressure for the past year, as investors have tried to predict whether the British winds are blowing in favor of staying or leaving the EU. The pound lost more than 10% of its value against the dollar between August 2015 and February 2016. Last April, it sank to a 2016 low of 1.41, but it had started to recover on seemingly good British economic indicators since then.
A poll, which The Independent published last Friday, may hold the greatest responsibility for putting pressure on the pound. It suggests that 55% of Britons want a Brexit, while 45% would prefer to stay in the EU. (Source: “EU referendum: Poll reveals 10-point swing towards Brexit as Leave campaign gains momentum,” The Independent, June 13, 2016.)
The 10-point difference is the widest among those recorded so far. But what the results clearly suggest is that uncertainty remains supreme. This will maintain high volatility on the GBP. The poll results, from various sources—even those that show support for the Bremain position—are close. Yet the recent margin would prompt many to bet on the U.K. leaving Europe. The GBP’s course is certainly pointing to that direction.
Former mayor of London Boris Johnson has continued to speak against the U.K.’s membership in the EU, perhaps persuading some more Britons to the cause. Johnson has even suggested the notion of linking Britain to Australia. (Source: “Brexit would bring Britain and Australia together, Boris Johnson says ahead of referendum,” ABC, June 13, 2016.)
There are various studies examining the economic impact of a Brexit. They only add to the confusion. Some, like the one that PricewaterhouseCoopers recently published, predict a 3.5%–5.5% drop in the value of Britain’s gross domestic product (GDP). (Source: “Leaving EU would cause a serious shock to UK economy – new PwC analysis,” CBI, March 21, 2016.) Others suggest the opposite: Britain’s GDP would gain two to three percent. (Source: “Brexit Economists Hit Back Back With Claim U.K. Would Thrive,” Bloomberg, April 28, 2016.)
Wolfgang Schauble, Germany’s finance minister, suggests the most plausible prediction. He said that a Brexit would damage both parties and could redefine the eurozone’s relationship with the U.K. He said that as an outsider to the EU, in the case of a Brexit, Britain would no longer enjoy direct access to the EU’s single market. (Source: “No single market access for UK after Brexit, Wolfgang Schäuble says,” The Guardian, June 10, 2016.)
But as for the British pound and the GBP to USD exchange rate, the Fed will likely leave rates on hold pending the outcome of the British referendum. If Janet Yellen, Fed chairperson, were to raise rates now, it could push the U.S. dollar excessively high with respect to the cable—yet an interest rate hike is likely before the end of the year.
The big factor is whether the fear of immigration is stronger than the fear of economic uncertainty. The Brexit referendum plays on these opposing concerns, agitated by the two camps, which exaggerate their positions to provoke fear over the consequences.
But it is undeniable that the debate over Britain’s exit from the Union would fuel uncertainty in the British economy for the next few years. This scenario will put pressure on the British pound for a few years to come; it will also keep the markets in check for the next few weeks. The Brexit possibility has already produced a destabilizing effect, with other countries possibly holding their own referenda to leave.