The Strategist

Is there any possibility that Brexit stops influencing the Pound sterling?

12/25/2018 - 10:14

Right now, no one in the world knows what the Brexit will be like. Will the parties have a deal, that is, Prime Minister Theresa May’s highly criticized Agreement on withdrawal, or there won’t be any deal at all? Will the EU make concessions or will it extend the discussion of conditions after the March term? And will Brexit take place in general, taking into account the ruling of the European Court that the UK can cancel the 50th article of the Lisbon Treaty unilaterally and rejoin the European Union?

Public Domain Pictures
Public Domain Pictures
Currency traders like this uncertainty, but serious investors do not. The unpredictability around Brexit and the constant analysis of its likely consequences have already led to an increase in income from currency speculation. However, international companies delay decision-making considering the possibility of direct investment in the UK. In 2017, the growth rate of foreign direct investment in the United Kingdom fell to 0.8% - this is the weakest dynamic since the 2009 recession. In fact, this figure means a sharp drop, because in 2016 foreign investment in the British economy increased by 15%.

For two and a half years of uncertainty, the pound sterling lost about 18% of its value against the US dollar. The currency was trading at $ 1.44 before announcement of the referendum, but by the end of October 2016, its rate sank to $ 1.22 and then remained extremely volatile. This year, having strengthened to $ 1.42 in April, the British currency rate slipped back to the level of $ 1.26 in December.

Now, many people are concerned with a question: will the cost of the British pound change so significantly after the country leaves the EU? According to the IMF, the pound sterling was overestimated by about 5-15% in February 2016. This result is consistent with estimates of the fundamental purchasing power parity (PPP) of a number of leading currencies, including the pound, against the US dollar, which have been measured monthly by the global economy since 2014.

Estimated value of currencies at PPP is based on international complex studies, which consist in comparing prices with market exchange rate ratios. According to these data, the cumulative effect of the referendum and the victory of the campaign for leaving the EU significantly reduced the rate of the pound sterling against the dollar. The British currency lost an unjustified premium of 5% of its value in June 2016, and five months later, it was underestimated by about 14%.

Although the short-term effects of speculation will still affect the daily market value of the pound sterling, there are some signs that foreign exchange markets will increasingly focus on fundamentals. The number of Brexit options has decreased: Theresa May postponed parliamentary vote on the agreement on withdrawal from the EU until January next year and categorically ruled out a second referendum as a "betrayal of democracy." And while the Prime Minister is trying to find common ground with the EU authorities on the issue of Northern Ireland, foreign exchange markets regard this situation as a signal that the deal is unlikely to be agreed, and make appropriate bids.

Recently, another information factor has been added to this. On December 18, the British government began seriously preparing for a no deal - the so-called refusal to deal with the European Union. In some circles, this is viewed as the worst-case scenario for UK foreign trade, which may lead to a decline in the standard of living of the British and a slowdown in the economy.

In turn, optimistic supporters of the no deal, such as the Free Trade Initiative in conjunction with the staunch “Brexitters” in the British parliament argue that in this case the UK will trade according to WTO rules, freeing itself from the shackles of the European Union. deal quickly and without obstacles.

It is clear that, according to the first scenario, the value of the pound will fall sharply, and will steadily increase according to the second. However, objective assessment of impact of Brexit on the British economy and national currency will take years. Now the reality is that, despite the lingering uncertainty surrounding the UK exit from the EU, the current rate of the pound sterling is not much lower than the fundamental value, which is about $ 1.3.

In the future, any weakening of the pound, caused by fears of the Brexit hard scenario or stock speculation, can be considered as an opportunity to purchase British assets, in particular real estate, at a lower price. The country's withdrawal from the EU with the deal will further bring the pound closer to its fundamental values.