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How could Brexit affect the pound?


How much could the UK pound fall? Why? Could it bounce back? What’s the long-term expectation for the pound if there’s a no-deal Brexit?

The day after the UK voted for Brexit the pound suffered the biggest single day loss for a G10 currency in recorded history; it lost around 8% against the dollar (USD). If Britain really ends up facing a “no-deal” Brexit situation the pound could potentially replicate this decline.

However, given that the UK economy is still moving upwards in small increments and given the preparations of the Bank of England, the pound is likely to regain some ground quickly in the short term, but not fully recover. Instead it is more likely to start trading from a new lower level.

Brexit and the pound: alarm bells ringing

The likelihood of the no-deal option is increasing by the day as the government remains far too deeply divided on Brexit to be able to form a uniform strategy. The loudest alarm bells on this issue were rung by the Bank of England governor Mark Carney last week.

Although the Bank voted unanimously to raise interest rates to 0.75%, the highest level in a decade, Carney made clear that there would be no interest rate hikes until next year because of the uncertainty over Brexit. He said that the possibility of a no-deal Brexit was uncomfortably high and that both the UK and EU should “do all things to avoid” a no-deal scenario. His comments triggered a decline in sterling to an 11-month low of just under $1.30.

For the moment, although the pound is not firming much, there is a false sense of a lull in the market. The weather is still hot, MPs are on holidays and the battle over who will steer the UK through Brexit, or potentially out of Brexit, has temporarily died down. However, come September there will be a full house again in Westminster, the party conference season will start and it is possible that the Tory rebels who started making their moves when the Brexit minister David Davis resigned, followed by the then Foreign Secretary Boris Johnson, could finish their game and challenge Theresa May’s leadership.

What chance a general election?

If this happens, the direction sterling starts trading in will depend on who takes over Theresa May’s position – a staunch Brexiteer or pro-European anti-Brexiteer. If the choice is too extreme, particularly if the pendulum swings too far in the hard Brexit direction, it is not beyond the bounds of possibility that the Labour party would wade in and call for an early election. This, of course would make the likelihood of a no-deal Brexit even higher simply because it would delay the normal processes of negotiation while there is a change at the top.

On the upside, BoE’s Carney said that the Bank has prepared for the uncertainties ahead by “stockpiling” and that Britain’s financial system was in a position to be able to withstand a shock that could result from the UK leaving the EU without an agreement.

In the short term, given that no more interest rate rises are in the picture well into 2019 the pound could struggle to make any significant moves higher.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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