Just like the 1970s British punk band The Clash, the United Kingdom must decide “should I stay or should I go now?” Just as the protagonist in the song, the European Union (EU) is suffering from Britain’s indecisiveness. The British pound had been one of the highest-selling currencies in recent weeks. The approaching risk of a “Brexit” (Britain exiting the EU) could have negative repercussions for Her Majesty’s economy—and certainly for its sovereign risk. George Soros-style financiers are already salivating at the prospects of a British pound collapse.
The uncertainty is adding another layer of risk to the markets. It is unclear if British Prime Minister David Cameron will be able to reach an agreement in Brussels with other EU members. The U.K. is asking for many exceptions. Most economists agree that the increased risk of a vote to leave the EU would fuel uncertainty. This would block foreign investment and slow consumption, hurting the eurozone’s economic growth.
Many EU members may refuse to bow down before London’s demands. Meanwhile, British polls suggest Brexit supporters and detractors are split rather equally between leaving and staying in Europe. Of course, all this uncertainty in the market carries a price.
The pound has seen some of the biggest depreciation among major currencies. The risk of a Brexit has played a significant role in this development. In the face of the rising Brexit risk, how much more risk can the pound absorb? What will happen if British citizens actually vote to leave the EU?
A Brexit could cause a chain reaction from a collapse of the pound to lower gross domestic product (GDP) and higher domestic risk. These are just some of the evident consequences. Of course, if the U.K. and the EU reach an amicable separation arrangement, the effects would be muted. A mutually agreeable separation, accompanied by peaceful negotiations, would soften the macroeconomic impact. But, the possibility of an ugly divorce is higher. Nobody has left the European Union or its founding institutions.
A prolonged agony would put pressure on the European stock markets, starting in London itself. Of course, the British pound would be teetering, attracting the attention of short sellers like George Soros. The Bank of England has increased foreign currency reserves to protect the U.K. from attacks from financiers like 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.)
Soros made a rather nasty name for himself in the U.K. He nearly broke the Bank of England in 1992 by betting around 10 billion pounds on the devaluation of the British currency.
Evidently, a Brexit puts pressure on the pound. Large British companies with significant business in Europe would suffer from the move. On the contrary, were the U.K. to remain in the EU, it would stabilize the currency, improving business confidence and supporting economic growth.
The uncertainty disturbs investors. The same uncertainty may have already influenced the Bank of England, given the soft tone of its governor’s recent speech. He postponed a rate hike until 2017. This weakened the British pound’s value in January, which has an obvious impact on the GBP to USD exchange rate.
The weaker pound would increase the cost of goods due to the depreciation of Britain’s currency. Then the British retail sector would suffer and its supply chains are notoriously international. If the United Kingdom stays in the EU, businesses would benefit from a more favorable regulatory environment.
Not one of the more than 100 famous economists consulted by The Financial Times believes that leaving the EU would be good for the growth. Some 67% think that the prospects of the country would worsen significantly. (Source: “Economists’ forecasts: Brexit would damage growth,” The Financial Times, January 3, 2016.)
Of course, the simple answer when it comes to what will happen to the British pound and the GBP to USD exchange rate if a Brexit were to occur is…time will tell.