For the past 6 months or so, the British currency has been under the heavy influence of political risk due to the ‘Brexit’ vote. Speculation that the UK might have to leave the European Union, according to the outcome of the June referendum, have been plaguing the currency. The exact impact of such a decision is very difficult to measure; the ‘leave’ camp claims it will not have any appreciable effect while the ‘remain’ camp warns of a serious economic hit if ‘Brexit’ takes place. Financial markets and many investors have erred on the side of caution as they sold sterling and drove the cost of insurance against sterling weakness to high levels.
However, the latest developments such as the polls turning more favorable to the ‘remain’ camp and the position the US President Barack Obama has taken on the issue, have led to a reduction in worries that ‘Brexit’ will take place. This has helped the pound to rally back from its near 6-year lows versus the dollar to make a 2 ½-month high. It is reasonable to expect that the smaller the probability of Brexit becomes, the discount at which the pound is trading will also shrink.
One should be cautious of dismissing the danger of ‘Brexit’ too quickly. The supporters of the ‘leave’ campaign are a lot more passionate than those of the ‘remain’ camp, who usually base their support for the EU on economic, financial and trade factors. Therefore on the actual vote day, the ‘leave’ campaign supporters are more likely to actually go to the polls and vote rather than the supporters of the ‘remain’ camp. Of course one could also claim that if the ‘leave’ campaign looks like heading for a big defeat, the passion of its supporters may also subside and many of them might not turn up to vote. This is not mentioned to confuse the issue with arguments and counter-arguments but just as an illustration that adopting a definite scenario that Brexit will ultimately be avoided (as we have repeatedly made the case in the past) without taking into account the risks of an upset, could be a very costly mistake.
For the moment though, it looks more likely than not that ‘Brexit’ will indeed be avoided and pound-watchers will revert to closely following the Bank of England and the key economic statistics of inflation, unemployment, economic growth etc. These factors have unfortunately taken a back seat lately due to the raucous campaigning for the future of Britain in or out of the EU. The Bank of England has been particularly careful and maybe even somewhat worried, ahead of the referendum. Even if Brexit is averted, the uncertainty surrounding it could cause some economic damage during the first half of the year. Tomorrow’s first estimate of UK GDP growth for Q1 will contain some important clues to answer this question. The statistic will be very interesting to those investors that hope sterling – in 2 months’ time – will become a less exciting, ‘normal’ currency again that fluctuates according to economic and monetary news and less about political risk and cliffhanger votes.
