Brexit becomes a reality
The polls had it as close, the bookies didn’t and as dawn breaks, the UK has voted to leave the European Union. GBP, after initially running up to 1.50 against the USD after the first polls, has crumbled and touched lows not seen for over three decades.
The movements have been swift and vicious and the intraday price changes in GBP/USD have been more than what we saw on Black Wednesday when sterling withdrew from the Exchange Rate Mechanism.
The usual caveats exist about liquidity but these moves are concerning and bring back pretty painful memories of 2008. GBP/USD didn’t have this bad a day in the Global Financial Crisis and the weakness in sterling persisted as the vote was confirmed.
A leave vote has already been incredibly negative for sterling and City and Canary Wharf traders could come out swinging in a bid to take the pound lower still as the results pervade throughout the UK. Fears over the twin deficits – current account and budget – alongside concerns over a possible recession, interest rate cuts or increased quantitative easing from the Bank of England are all reasons why GBP will be very unloved.
Should sterling continue to suffer, GBP/USD is in danger of declining to the low 1.30s. For every 1% the USD is gaining against the pound, the euro is gaining about 0.66%.
The Bank of England has reassured markets that liquidity will provided when necessary, however this will still allow the pound to be devalued by the markets and will only smooth the descent as opposed to prevent a fall. Of course, a hike in interest rates could boost the pound as well as help with expected higher inflation that a devalued currency would likely bring.
The Bank of England has form in ignoring inflationary pressures on both the high and low side of its mandated 2% target and we believe that they would probably cut interest rates and boost asset purchase programs such as quantitative easing in a bid to keep lending and credit markets flowing in an orderly manner.