Brexit Adversely Affecting the GBP
The Brexit referendum has changed the course of the British people and the economy. The British people voted to leave the EU 51.9% to 48.1% on Thursday 23rd June 2016. The participation rate was 71.8%, with more than 30 million people turning up. To say the least it was an important matter. But the result was not the same everywhere. Scotland and Northern Ireland voted Remain by 62% to 38% and 55.8% to 44.2% respectively.
Brexit divided the country about immigration and the economy with some defending the idea that the UK would be better off on its own and others proclaiming the opposite. Financial markets were among the latter. As a result the British Pound fell immediately after the referendum results were made public.
Amid the uncertainty provoked by the vote, the Prime Minister David Cameron resigned and was replaced by his Secretary of State Theresa May. She then officially launched the formal two-year process to leave the EU pushing the country onto the uncharted water of negotiation. Talks started effectively on June 19th 2017. The outcome is uncertain and every EU member along with the British parliament must ratify any deal to make it effective.
Additionally, the many unknowns about the economy weigh on the currency. Trade conditions with the EU will change as soon as the UK leaves the single market. Depending on the details of the exit deal the country’s exports might be subjected to tariffs eroding its ability to compete on the European market. It would also have to negotiate new deals with every other major trading partner.
The weakened Pound is expected to bolster inflation since imports will be pricier, in turn hitting the domestic demand and purchasing power of the British. Local industries could benefit from this trend and thrive if they are not too dependent on foreign raw materials. Exports should become more competitive. However the probability of facing tariffs on the previously open European market will be detrimental to the their development.
The industry to be hit most is clearly the financial sector with banks expected to lose access to the single market. Thus most have laid out plans to move part or whole business parts to other European financial centers to keep their market access. The main benefiters are Frankfurt – which will welcome Sumitomo Bank, Deutsche Bank, and JP Morgan whom are moving thousands of well-paid jobs –, Paris – which receives HSBC –, Dublin and even Brussels.
This shift in the financial sector will create a crunch on the job market and a loss of tax revenue for the government. Brexit might start a trend of multinationals moving away from London to other more stable international financial centers such as New York and Singapore. The interbank and currency markets will be the first to suffer in this case.
The move might also impact the real estate sector in the City of London where banks will reduce their footprint as well as the rest of the city where well-paid bankers rent or buy properties. Financial institutions are already reining any plans to expand in the UK. This will render London real estate less attractive to international investors due to the lack of growth prospects.
The Brexit referendum had a strong effect on the pound sending it to a low of 0.9120 against the Euro by the end of September. The fall of the pound sent inflation expectations up. So far the UK economy is still growing at a respectable pace at 1.8% in 2016 along with countries like Germany but the country has not left the EU yet.
The British Pound is seen as a riskier asset now and foreign capital is fleeing towards safe haven assets such the US Dollar, the Japanese Yen, the Swiss Franc or gold. The GBP might remain labeled as such as long as the negotiations with the EU do not yield clear results as to how the exit will impact the economy.
By the end of 2016 the Pound was at a low of 0.9120 against the Euro reminiscent of its crash after the 2008 financial crisis. It has recovered a little to 0.8780 against the Euro by the end of June 2017. But it is still far away from the heights of 2015 at 0.6930 against the Euro when confidence was favorable.
The Bank of England reduced target rates in August 2016 to their lowest level at 0.25% from 0.5% before the referendum . As of 2017 rates are still at the same level while countries like the US have returned to growth and have already started cranking up rates making the US Dollar even more attractive. The central bank has also bolstered its quantitative easing program by offering banks further venues to access liquidity to alleviate any liquidity risks.
In case of economic difficulties the BoE might be obliged to keep target interest rates lower for longer further undermining the potential of the Pound to recover thanks to the dynamics of the carry trade. A declining UK economy could contribute to lessening the importance of the Pound as a reserve and trade currency.
There are multiple outcomes to the negotiations. There is the possibility of a soft Brexit in which the UK leaves the EU but stays in the single market just like Norway, Iceland and Switzerland and respects the free movement of people which defeats the purpose of the initial vote. On the other end of the spectrum there is the hard Brexit with a UK completely out of the EU with closed borders for goods and people.
The GBP exchange rate will be closely linked to the evolution of the Brexit negotiations with the EU. The British currency may keep depreciating as the exit comes closer to a hard Brexit in which the UK might simply leave without any sort of deal. Otherwise the GBP could appreciate if the UK negotiates a customs deal and/or an access to the single market including financial sector passport.