Dire Warning for the British Pound
The GBP to USD exchange rate (often called the cable) has returned in favor of the pound. After the British pound was about to drop below the 1.40 mark, it went as high as 1.44. It is difficult to be a currency trader these days, but there is no doubt that the GBP/USD and the currency markets must come to terms with Janet Yellen. Whenever the chair of the U.S. Federal Reserve speaks, she affects currency valuations more than any other factor.
Yellen’s concerns over inflation and the related impulse to postpone a rate hike again have mitigated the effects of the Brussels terror attacks and the rising fears over the Brexit on the GBP to USD pair. For the next few weeks, Yellen’s words will have the effect of frustrating the high volatility that has characterized the bearish pressure on the British pound trend over the past month.
What is important for currency buffs to note is that the cable’s shift in favor of the sterling is stemming less from the Bank of England’s favorable British economic indicators and more from the sharp depreciation of the dollar and Yellen’s accommodating interest rate policy. Despite favorable British economic indicators, the shadow of the Brexit is looming ever closer. Therefore, the GBP’s bullish tide could be rather short-lived.
The cable will become more volatile as the June referendum approaches. Indeed, the fear in the U.K. is palpable. Almost all of the financial institutions have urged the British to vote in favor of keeping the U.K. in the European Union. They want to defend the GBP and the world economy from a shock. However, Bank of America Corp has taken a step further. It urges its analysts to avoid proffering opinions on the course of the referendum, banning them from even using the term “Brexit.” (Source: “Bank of America warns staff on use of the word Brexit,” The Financial Times, March 29, 2016.)
These are clear indications that the U.S. bank has provided its managers, designed to bring the institute to full neutrality. In this perspective, BofA felt that the term “Brexit” alone has encouraged decidedly negative connotations for the GBP. Indeed, American banks based in London have much to fear should Europe lose in the event of the withdrawal of the U.K. from the EU.
While BofA has decided to avoid the subject, Goldman Sachs Group Inc has funded the “Stronger in Europe” effort, donating thousands of pounds. JPMorgan Chase & Co. and Morgan Stanley have held similar campaigns. A significant amount of financial exchanges currently registered in London could vanish with a Brexit.
Just last week, the GBP to USD exchange rate dropped over a full percentage point against the dollar and the euro. The Brussels attacks raised the prospect of a rise in hostility of public opinions over immigrants and refugees in the U.K. This is the very sort of thing that could swing voters in favor of a Brexit in the United Kingdom in the referendum over leaving or staying in the European Union to be held June 23. The closer the outcome weighs in favor of the Brexit, the more the GBP/USD rate moves in favor of the dollar.
Despite better-than-expected industrial and manufacturing results from earlier in March, the sterling remains susceptible to the prospect of the Brexit, which many predict would hurt the U.K. economy. The GBP will be the main victim of a Brexit scenario. The governor of the Bank of England, Mark Carney, has warned the British financial establishment that the U.K.’s potential exit from European Union is the biggest internal threat to Britain’s financial stability. (Source: “Mark Carney Says Brexit Is Biggest Domestic Risk to U.K. Financial Stability,” The Wall Street Journal, March 8, 2016.)
Uncertainty is a new sensation for Britain. Over the past five years, many considered the U.K. an island of stability at the edge of a eurozone in the eye of the storm—many storms actually. After the dark days of 2008 to 2009, in which the government had to nationalize some banks, the economy is restarting.
Unemployment has fallen and the London property market has reheated after the post-financial crisis slump. By all accounts, London has become a safe haven for international capital. The pound had started to rise again, thanks to the expectation that the Bank of England would raise interest rates from the near-zero levels of the 2008–2009 crisis. But the Brexit referendum has shaken the “Island of Stability,” making the GBP to USD exchange rate a haven for speculators.