Uncertainty surrounding the Brexit process has continued to dominate the headlines and drive much of the volatility in the foreign exchange market in the past few weeks.
Sterling has fallen sharply since the beginning of May, a direct result of the heightened expectations that the UK could be set to leave the EU without a withdrawal agreement in place come the 31st October deadline. A good indication of the heightened risk is the bookmaker implied odds for a ‘no deal’, which have risen to back around 30% from approximately 15% only a matter of weeks ago. This has sent the Pound to its lowest level in nearly five months against the US Dollar (Figure 1).
Figure 1: GBP/USD (March ‘19 – May ‘19)
Source: Thomson Reuters Datastream Date: 28/05/2019
Increased bets in favour of a ‘no deal’ Brexit were triggered firstly by the collapse in cross-party talks between the Conservatives and Labour Party. The discussions were hoped could find common ground and yield a majority in favour of Theresa May’s Brexit deal. Already faint optimism that May could force her thrice rejected Brexit withdrawal agreement through a fourth parliamentary vote effectively evaporated followed the end to the talks. Theresa May’s last ditch plans to force her agreement over the line, which included offering MPs the chance to vote on whether to hold another referendum, also subsequently failed and ultimately led to her resignation as Prime Minister.
Attention in the financial markets now turns to who will replace May. Former London mayor and pro-Brexit Boris Johnson is being lined up as the bookies favourite to be the next PM. We think there is a risk that his appointment could pressure Sterling lower if the market perceives his leadership as increasing the possibility of a ‘no deal’. Johnson has recently intimated that he is not as overly concerned regarding such a scenario as many of his fellow Tory leadership candidates.
A ‘no deal’ Brexit would undoubtedly be the worst case scenario for the Pound and, in our view, could lead to a knee-jerk sell-off in the currency of anywhere between 5-10% from current levels. By contrast, we would undoubtedly see a sharp upward move in Sterling in the event that a Brexit deal is somehow forced through parliament at some point between now and the end of October. We do acknowledge, however, that this may now require the holding of a general election and a new parliament.
As for the recent European Parliament, the reaction in the currency markets was actually rather muted. The results were, on the margin, modestly positive for the Euro, with the populist anti-EU parties doing somewhat poorly, and strongly pro-EU liberal and Green parties registered the largest gains. With the potential negative impact posed by the elections averted, downside risks to the Euro, much like the Pound, now rest firmly on whether UK politicians can reach an accord over the terms of the UK’s exit from the European Union before the end of October.
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