Time to Bail on the British Pound?
A little over a month is left before Britons vote over their country’s membership in the European Union (EU) and the British pound has regained confidence. It might even be possible to suggest that the British pound is stronger as fears of a Brexit have waned and the pro-EU camp, the so-called “Bremain” side, has gained strength.
Indeed, on May 17, the British pound reached its highest level in the past three weeks. The surge in the GBP to USD came as the Evening Standard and Ipsos published a survey showing that the pro-EU membership camp has an 18% lead over the camp of those who wish to remain within the EU. (Source: “Britons don’t believe Brexit risks peace, poll shows – but Remain pulls ahead,” Evening Standard, May 18, 2016.)
The survey results have shown that a large group of “moderate” Euroskeptics is moving over to the Bremain camp. The British pound has skyrocketed in value in a matter of hours. The GBP/USD pair, also known as the cable, has experienced a flare up, hitting $1.46 in a few hours. This marks the highest level for the cable since June 3, 2015.
More significantly, while the pro-EU voters maintain the lead, the interesting aspect is that Britons appear less frightened by the gloom and doom predictions in case of a Brexit. (Source: Ibid.)
This easing of fear may have contributed to the GBP’s long-term strength. The British electorate is sending the message that it wants to stay, but if Britons vote to leave the EU, it’s no big deal, regardless of what some politicians and businesses are saying. The poll says voters are stacked 55% against and 37% for a Brexit.
For currency investors, the takeaway is that after a period of relatively higher GBP/USD volatility, the British currency appears to have already absorbed the worst of the downside risk. Judging by the polls, the Brexit referendum will have more political than economic costs. Indeed, Prime Minister Cameron himself, who has come out strongly in favor of Britain’s EU membership, would likely resign if his camp were to lose.
But, even in the case of a Brexit, the EU will not stop trading with England, suggesting the customs barriers would be more symbolic in nature, similar to those that exist between Switzerland and the rest of the EU. What might change is London’s role as the European financial center and a virtual tax haven for many companies. Foreign investment could dry up, causing Britain’s current account to dwindle. That would certainly drive the British pound lower—especially with respect to the euro.
For the time being, however, the GBP is stronger against the euro, as the European economy struggles to restart and inflation fails to pick up, even though demand and prices have rebounded. Indeed, the euro has weakened against the dollar.
Nevertheless, while the Brexit debate continues, despite the pro-EU camp (i.e., those fighting for a stronger GBP), the British currency will not make any sudden moves.
Britain’s Prime Minister Cameron has warned of risks to “peace,” while Bank of England Governor Mark Carney has cut the British economy’s growth, not excluding a technical recession in the case of a pro-Brexit win.
Last week, the cable fell back to below 1.45. But, if the GBP has not fallen more sharply against the U.S. dollar, it may be due to the higher oil prices than to the Brexit risk.
Typically, there is a negative correlation between the dollar and oil prices: the higher the latter the lower the former. West Texas Intermediate (WTI) crude oil prices, the American benchmark for crude oil, rose above $47.00 per barrel. The massive wildfire in Alberta, Canada has also cut production by some half a million barrels a day. This should be putting pressure against the dollar.
Still, given that the GBP jumped because of a survey, it could easily drop if another survey shows a different outcome, one less favorable to Bremain side. In other words, volatility of this kind needs extreme caution when trading the GBP to USD exchange rate—at least until the fate of the United Kingdom becomes entirely clear.