BBGFX Update: Our Thoughts on a “Brexit”

As we approach the U.K.’s EU referendum on June 23, Bannockburn Global Forex, LLC has put together their thoughts on potential outcomes for a remain or leave vote below. 

At the time of this writing the spot rate for the Gbp/Usd is 1.4250 and Eur/Gbp .7935.

As evidenced with the June 13 Gbp/Usd trading range of 1.4116 – 1.4321 (being a 1.5% range), we expect the daily volatility for any Gbp related currency pair to remain elevated as we approach June 23. Graph for Gbp/Usd can be found here. Current sentiment for the vote sides with remaining in the EU, but recent polling has indicated the vote to leave is gaining momentum. We believe the possible downside, as described below, to leaving the EU will signal to the voters the risks of an exit is just too high, and issues revolving around sovereignty and refugees can be dealt effectively while remaining in the EU. However, anytime a referendum vote is on the table, the result is unpredictable and this case the vote is likely to be close. As such, we have seen both speculative and risk protection hedging trading expand as the possibility of an exit vote becomes more pronounced leaving the markets more prepared should the leave vote materialize.

If They Vote to Leave:
GBP is expected to see a sharp sell-off in immediate reaction to a Leave victory, falling to February’s 1.3836 low and then test key support in 1.3450 region. It is difficult to predict if these levels will be breached within minutes, hours or days (assuming GBP is trading around current 1.4250 level, however it will be extremely volatile trading). Overall market consensus for downside risk to GBP is eventual  losses of potentially 10-20%, which means GBP/USD could trade as low as 1.30 and even 1.15 levels against the USD, if this scenario develops.

Why will GBP sell-off?
Uncertainty for the UK economy – Trade, Foreign Investment, Immigration, Regulatory, Political.
Trade represents one of the largest risks as access to EU markets would reduce in aftermath as current trade agreements would eventually lapse. The EU is critical to UK economy given it is the main trading partner with approximately 50% of UK’s trade activity (both imports/exports).  The UK benefits from existing trade agreements (lower trade barriers) and any Brexit would require these to be renegotiated – risk of less competitive terms.

Lower Economic Growth, Analysts are predicting the following potential outcomes: 

• ​​​Annual GDP would reduce by 1-2% in any Brexit scenario.
• CPI could climb as high as 5% due to imported inflation.
• Uncertain monetary policy as Bank of England would be reluctant to raise interest rates (divergent to U.S.)
• Sharp deterioration in Trade Deficit

Potential Impact on other Currencies

• USD –  benefit from safe haven flows and yield spreads (further divergence in monetary policy)
• EUR –   strengthen against GBP, but could see it weaken on other major crosses. Markets will view any Brexit as potential risk for Eurozone to break-up and other countries to follow the UK’s lead, which would create further uncertainty.
• JPY –  benefit from safe haven flows
• Commodities (and commodity currencies)– weaken as  negative for global growth on risk of Eurozone break-up (not UK Brexit alone) and risk-off sentiment

If They Vote to Remain: 
GBP could see a knee-jerk reaction higher, allowing the currency to shake-off the past few months burden of the EU Referendum. This could see GBP breach the recent 1.48 area highs and even potentially target 1.50 in the current illiquid markets. Any gains may be temporary as the focus will return to the lackluster UK economic performance in recent months, leading the currency to trade back around the mid 1.40s once again. Also likely is that all eyes will return to the Fed and the timing of the next U.S. rate rise, ensuring GBP direction is once again driven by U.S. yield spreads.

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