The Pound’s Junket Is Not Yet Done

Our report on the Pound’s performance since Article 50.

Since the UK’s vote for Brexit in the June-referendum, and dumping of the currency by investors, the sterling had been crashing, making the Pound the worst performing currency in 2016, across the world among the G10 currencies. The possible reason cited for the slip of the Pound against the Euro and the USD was the markets’ pricing for a ‘very hard Brexit’ as well as UK’s sharp economic deterioration. The Sterling’s downfall against these currencies and the Yen was pressurized by the doubts over whether the Bank of England would raise interest rates as well. As predicted, the Central Bank will hardly tighten the monetary policy amid Britain’s negotiations for Brexit over the next two years.

There are many political and policy-related occurrences that will affect the Pound. The suspected suicide bombing of St. Petersburg bombing in Russia, the arranged meeting between Chinese President Xi Jinping and United States President Donald Trump, and the French elections towards the end of this month, are just a few of the economic situations that the Pound may respond to.

Political uncertainties have been the force behind the Pound’s trend, with the currency depreciating by 17 per cent against the U.S Dollar since UK’s vote for Brexit in June. On Tuesday, the Pound depreciated at 0.25 percent, selling at 85.70 pence per Euro. The Sterling fell by approximately 1 percent resulting in a 12-week low of 137.24 Yen.  Overall, an 11 percent fall in the Sterling value against the Euro has left quite dazed over its future course.

 

However, the Pound remained stable, if not volatile, in the recent months. The triggering of Article 50 starts Brexit’s 2-year countdown. May’s mid-January Lancaster House speech, along with UK’s economic resilience has kept the Pound above USD1.20. The government’s legal difficulties regarding the Brexit policy have been forgotten after steering Article 50 through the House of Lords.

Article 50 has posed a rather modest impact on the Pound. In mid-March, the Pound rose above USD1.22, with a 0.5 percent gain against the Euro to £0.8735. The currency appreciation partly demonstrates the investors’ acceptance of Brexit – with no uncertainties, with them buying and selling in the reality of the upcoming UK-EU divorce. Uncertainties associated with Brexit are now priced into the Pound. Further, triggering Article 50 will be noticed by the investors. Despite being a significant market-moving event, additional weakness may arise, particularly involving a test of January low. More substantial could be EU’s response following the announcement, and its decision about the Brexit negotiation process.

Given the fundamental health of the UK’s economy, the Pound can be considered cheap, with a 2 percent growth forecast this year. Several factors are assuming greater value to investors than the triggering of Article 50. These include the risk of Brexit on domestic investment, increased devaluation of the Pound on corporate Britain, prospect of a US interest rate hike, the French presidential election, and the relationship between EU leaders and Theresa May in the run-up to Brexit negotiations.

The Pound’s implied volatility (versus the US Dollar) has been on a downward trend. Development in other countries will determine the Pound’s direction. Accordingly, the longer it takes for the UK’s future trading relationship with the EU uncertainty to last, the longer would be the possibility of downside pressure on inflation, employment growth, and investment spending.

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