Forex – how the pound could be affected by Brexit


Sterling has had a topsy-turvy start to the year, and there is one thing that seems to be driving the price action – Brexit.

The prospect of Britain leaving the European Union (EU)is unnerving markets from stocks to bonds, but arguably the biggest impact is in forex.

Judging by the predictions from economists, analysts and various commentators, there is pretty strong chance of a selloff in the pound should Brits vote to leave come June 23rd.

Longer run concerns about Britain’s economic health and the prospect of looser monetary policy, moreover, means there is no guarantee the pound will rise should Britain stay in the camp. It’s going to be a long night for traders either way.

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2016 so far

 

Trading on the pound has been volatile so far, with GBPUSD reaching its lowest ebb in seven years in February when Boris Johnson threw his weight behind the leave campaign. In the 12 months to the end of March the pound had dipped 11%.

As we noted in our previous post on sterling and the Brexit vote, the implied volatility for three-month options contracts has been a lot higher than usual, rising above the levels seen ahead of the 2014 Scottish referendum and last year’s General Election.

A subsequent rally – as polls showed less support for Brexit – has seen sterling recoup some of those losses, but it’s still down around 2% this year on the dollar. The euro, meanwhile, has been on the tear against the pound since November and is trading not far off its best level in 18 months.

Brexit predictions

 

Various analysts have estimated that the pound could fall by around 20% if Britain votes to leave the EU.

The latest prediction of this sort comes from the National Institute for Economic and Social Research, which notes that a weak pound would drive inflation higher and lead the Bank of England to raise interest rates.

Analysts are talking about cable trading in the range of $1.10 - $1.20 should Britain leave – a level not seen since the mid-80s, when Paul Volcker was taming inflation and the US dollar was on the march, culminating in the Plaza Accord to weaken the buck.

What about the euro?

 

A slide in the value of the pound would likely not be the only impact of Britain leaving. A recent poll showed significant numbers of Europeans from Germany to Greece are in favour of having their own referenda on EU membership. Large numbers – although not a majority – say they would vote to leave.

Critically, Italy is showing real signs of wavering – 60% of those polled by ICM want a referendum and 48% would choose to leave.

The risk of contagion from Brexit is real and currency markets may punish the euro if they think the whole project is at risk. After a Brexit, what price a Grexit?

A weaker euro would probably be music to the ears of Mario Draghi, the European Central Bank boss who is desperately trying to stimulate inflation.

Britain’s referendum on EU membership takes place on June 23rd. Traders will be following polls closely until then for signs of where the pound might be heading.