Clouds over British Pound
The British pound has stabilized after a week marked by the respective interventions of the U.S. Federal Reserve and the Bank of England. Better-than-expected industrial and manufacturing results in the U.K. have failed to boost the GBP to USD exchange rate. The pound sterling remains weakened by the prospect of a “Brexit,” which many predict would hurt the U.K. economy. Meanwhile, the U.S. dollar suffered slightly amid speculation that the Fed will not tighten monetary policy in 2016 with another rate hike.
The current GBP to USD exchange rate stands at US$1.42. As next June’s Brexit referendum approaches, the likely scenario is for that rate to drop to US$1.38 in the short term and much lower in the longer term. An exchange rate of US$1.30 is more than plausible, if the bearish scenarios of Britain’s departure from Europe materialize. The lowest point in recent weeks was US$1.39 on February 21; not surprisingly, this was as London’s colorful mayor, Boris Johnson, punted in favor of the Brexit. (Source: “British pound plummets after London’s mayor backs Brexit,” The Washington Post, February 22, 2016.)
The GBP will be the main victim of a Brexit scenario. Indeed, 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, composed of 28 countries, 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.)
A Brexit would also prompt many big banks to leave London. The U.K. would simply cease its role as a global financial superpower. Carney stressed that his was not a political stance; instead, he was merely offering a technical opinion over the fate of the world’s fifth-largest economy.
The governor also added his voice to those discussing a general concern that a Brexit would cause the majority of the global banks to leave London if Britain were no longer able to ensure the same level of access to the EU financial system as it does now. Of course, if the U.K. and the EU reach an amicable separation arrangement, the breakup would be quieter and may not have such harsh effects.
A mutually agreeable separation, accompanied by peaceful negotiations, would soften the macroeconomic impact. However, the possibility of an ugly divorce is much higher. Nobody has left the European Union or its founding institutions. There may even be sharks waiting to strike, including short sellers like George Soros. The Bank of England has increased foreign currency reserves to protect the U.K. from attacks from financiers the likes of Soros. These would intensify during a Brexit referendum. (Source: “Waiting for the Brexit. A $98 billion war chest to save pound,” Britaly Post, February 11, 2016; http://www.britalypost.com/waiting-for-the-brexit-a-98-billion-war-chest-to-save-the-pound/.)
Mayor Johnson’s decision to side in favor of the Brexit has greatly increased the chances that, after more than 40 years of marriage, Britain will divorce the EU. The collapse of the GBP on February 22 and its inability to rise in the face of favorable economic indicators have given the markets a small taste of what a Brexit might feel like. Now, there will be a lot of uncertainty on the British pound.
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 that was caught in the eye of the storm—or many storms actually.
After the dark days of 2008/2009, 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 again to rise, thanks to the expectation that the Bank of England would raise interest rates from the near-zero levels of the 2008–2009 crisis. But can it survive a Brexit?