Jonathan Watson, Chief Market Analyst, currencies.co.uk
The Pound has fallen an enormous 18% since the UK’s Referendum in June. With predictions that the UK would suffer a recession if it decided against the status quo its managed to hold its own in the face of huge uncertainty.
But Sterling, which traditionally rises and falls based on economic cycles and data has taken a different course in recent weeks. We have witnessed how strong economic data has little impact on Sterling strength and instead, is being driven by economic sentiment and the post-Brexit landscape.
Sterling is on a freefall and it could get worse before it gets better.
Why is Brexit causing the Pound to fall?
Brexit has created a huge void for the British economy as it relies heavily on imports from its European trading partners. The whole purpose of access to the single market was to ensure goods and services are freely accessible amongst its members.
The UK’s largest exports to the EU are its financial services, and given that London provides most of the World’s interconnecting transactions to the rest of Europe and the US it is vitally important it holds on to its passporting rights and common trading framework.
If the UK leaves the single market it cannot access free movement of goods and services from the EU, a message echoed by many EU officials including EU President Donald Tusk and German Chancellor Angela Merkel.
Brexit therefore threatens the UK’s financial sector and puts hurdles in the way for businesses that rely on trade. This affects everyone on the supply chain from farmers to consumers as a weaker Sterling will have an impact on consumer prices.
But the biggest threat to the Pound is the uncertainty that Brexit creates. The Government have offered no official strategy as to how it plans to withdraw its membership and maintain current trading levels with the EU. And Given that curbing immigration is high on the priority list for the new Tory Government, it’s unlikely that the UK will maintain access to the single market.
When will the Pound improve following Brexit
One thing to mention at this stage is that the UK hasn’t left the EU yet and even when Theresa May gives her official notice via the famous Article 50, the UK will remain a member for at least 2 years.
During this period the UK will need to negotiate the best possibly terms with its remaining members and who will all have a say on what deal the UK receives. This will likely be a difficult time for the UK and investment will be put off until further clarity on the UK’s future becomes apparent.
And before we’ve reached the negotiation table, Parliament will need to debate endlessly what deal the UK plans to deliver with both sides throwing their weight at the subject. Both Conservative and Labour MP’s show different points of view on the matter which, in the longer term, will stall advancements and keep the UK in extended periods of uncertainty.
The Pound is therefore likely to fall further against its counterparts. the Triggering of Article 50 will put an official deadline on an EU-exit and will make markets nervous. Then there is the negotiation table which unfortunately, appears stacked against the UK in terms of securing a better deal. The remaining 27 members must balance their best interests against the UK’s.
Then there is the increase in consumer prices which could lead to a slowing of the economy, in turn this could lead to the Bank of England cutting interest rates further, another pain in the Pound’s side.
Therefore, the Pound is likely to remain on the weaker side for some time, political uncertainty will be the main driver of Sterling exchange rates for at least the next two years. And depending on what deal the UK is able to reach, Sterling vulnerability could continue well beyond these time frames.
If the UK is able to secure a similar deal to what it has currently, whilst maintaining access to the single market, Sterling will likely recover from its losses as confidence is restored.
However, in the event the UK were unable to negotiate a sensible deal with the EU, defaulting to WTO (World Trade Organisation) tariffs could hurt the economy. Forcing tariffs on German imports for example, will likely be passed on to the consumer which will only fuel a decline in consumer spending. I would expect this outcome to have a lasting impact on Sterling and the UK economy, until free trade agreements elsewhere can be secured.
The fate of Sterling depends therefore on many factors, but May and her Government must formalise a strategy for Brexit as soon as possible to avoid further slides. UBS predicted 1:1 against the Euro and as time ticks passes by, these predictions are looking far more prominent.