GBP/USD: This Could Crush the Pound to U.S. Dollar Exchange Rate

Pound to U.S.DollarThe GBP to USD exchange rate is suffering from the overall sentiment of risk aversion, the risk of a “Brexit” (Britain leaving the EU), and the expected slowdown in the U.K. economy. The British pound to U.S. dollar pairing, or the so-called “cable,” as forex traders call it, is at 1.45—its lowest level since 2010. (Source: “The equities markets are still struggling amid Chinese woes and oil free falling,” FXStreet, January 12, 2016.)

And this might only be the beginning.

The British pound had been one of the highest-selling currencies in recent weeks, because of bearish expectations of lower-than-expected growth in Britain in 2016 and to the approaching risk of a Brexit, which could have very negative repercussions for her majesty’s economy—and certainly for its sovereign risk.

Meanwhile, the British currency fell to its lowest value since the summer of 2010 against the greenback, but the GBP/EUR pairing has also suffered, such that the pound is trading at its lowest levels against the euro in the past three months. The GBP/USD exchange rate has dropped some 18% since the summer, when it was trading at 1.72.

The Recovery in the Cable Will Not Be Easy

Much will depend on the U.S. dollar and overall investor sentiment, which generally penalizes the pound in the early stages of the sell-off in financial markets. Meanwhile, the GBP is at its lowest level against the dollar since the beginning of June 2010, reflecting lower-than-expected industrial production statistics in the U.K.

The British currency has also plunged, because traders perceive that the Bank of England does not plan to raise its interest rates as early as expected, following the example in the United States, given the economic fundamentals. (Source: “Will UK Interest Rates rise in 2016?” What Investment, January 6, 2016.) Manufacturing output and industrial production failed to meet analysts’ projections. On January 12, the British Office of Statistics announced that industrial production fell by 0.7% on a monthly basis, suffering the largest decline since January 2013.

This adds to concerns over manufacturing, which contracted for the fifth consecutive month, falling some 0.4% in November and 1.2% compared to October and on an annual basis, respectively. These disappointing numbers have coupled with the rising fears of the Brexit scenario, adding ballast to any expectation of an increase in interest rates in the U.K. in the short- or medium-term. Indeed, the GBP/USD relationship should continue to move in the dollar’s favor over the next few months.

Brexit Could Be a Catastrophe for Britain

Leaving the European Union (EU) would mean sacrificing the United Kingdom’s future security and prosperity, according to a survey of experts. (Source: “EU referendum: UK businesses edging towards leaving as experts warn of Brexit risks,” International Business Times, January 4, 2016.)

Not one of the more than one hundred famous economists consulted by the Financial Times believes that leaving the EU would be a positive move for the growth, while 67% think that the prospects of the country would worsen significantly. (Source: “Economists’ forecasts: Brexit would damage growth,” Financial Times, January 3, 2016.)

Public opinion is rather more divided: the electorate is split in half on the issue, with a high percentage of undecided. British Prime Minister David Cameron has not launched a full campaign and whether he actually goes through with the notion is another matter entirely to convince citizens. However, if a campaign does start, it will likely happen after the EU summit in February.

PM Cameron considers this the crucial venue to reach an agreement over the reforms that London has demanded from Brussels. Frankly, there is no guarantee that Brussels will concede to the British leader’s demands.

Former British Prime Minister John Major, also a Conservative, had this to say about Cameron’s Brexit: “The whole world is coming together and for the United Kingdom, 67 million out of a world population of seven billion, to break off and head off into splendid isolation doesn’t seem to me to be in our interests now, or perhaps more important, in the interests of our children and our grandchildren and future generations.” (Source: “John Major: leaving the EU would push Britain into ‘splendid isolation’,” The Spectator, December 16, 2015.)

Most economists agree that the increased risk of a vote for the exit from the EU would be the next long period of uncertainty, which would block foreign investment and slow consumption, hurting economic growth.

The Bottom Line on the British Pound

A Brexit will cause “a huge self-inflicted wound,” according to Adam Posen, president of the Peterson Institute for International Economics. (Source: “Economists’ forecasts: Brexit would damage growth,” Financial Times, January 3, 2016.)

The immediate impact of a Brexit would be negative for the British pound, while in the medium-term, many banks and international institutions, which consider London to be the center of European finance, could choose to move elsewhere. (Source: “US banks plan ahead for UK exit from EU,” Financial Times, August 17, 2014.)

The move would start even before the referendum.