Brexit and its strong impact on currency exchange rates
The monumental Brexit has yielded political, cultural and also economical consequences. Here we explain how the UK's vote to leave the EU has led to significant Brexit currency impacts like lower currency exchange rates and the British pound devaluation.
By now it’s hard not to be aware that the UK’s vote for Brexit on 23 June 2016 had a significant impact on the currency market. But with news of long-term lows for the sterling, record highs for stocks and arguments regarding whether or not the country is heading for a recession, it can be hard to ascertain exactly what is going on. Most people don’t need to know how well the UK economy is performing when sending money overseas; they just want to know what is affecting how much they’ll get.
So what impact has the Brexit vote had on currency transfers, why are the markets reacting the way they are and what looks set to happen in the future? Foreign exchange provider TorFX explains the Brexit's important impact on currency rates.
How has the Brexit affected Pound Sterling exchange rates?
The pound has been consistently on the decline since the results of the referendum became clear on 23 June 2016. An initial sharp drop has been followed by several slumps and a persistent overall decline, leaving GBP to EUR -15 percent than pre-referendum levels and GB to USD and GBP to AUD down -17 percent immediately after the vote. This means people wanting to exchange pounds into other currencies are getting significantly less, while people wanting to buy pounds are finding the current levels particularly lucrative.
After the initial shock, the pound was further weakened by a series of unexpected political developments and poor data releases. Leading ‘Brexiter’ Boris Johnson cause a drop in the pound after surprisingly announcing that he would not run for Prime Minister after David Cameron’s resignation. A huge tumble in the UK’s purchasing manager indices – which measure activity in the manufacturing, construction and service sectors – sparked another sell-off. Plummeting consumer confidence, forecasts that sterling could hit parity against the euro, speculation that the government had no solid Brexit plan, warnings from international figureheads and worries that big businesses may move their operations out of the UK all combined to pressure the pound lower over the weeks following the referendum.
The tumbles have left the pound as the worst performing currency during the first half of 2016, beating even the currencies of places such as Venezuela, which is struggling with an estimated inflation rate of 700 percent.
Pound sterling in flash crash
The latest lows struck by the pound were caused by a ‘flash crash’, which happened during the Asian trading session late on the night of 20 October 2016. Many traders have set up computer algorithms to monitor the news and automatically make trades when certain parameters are met. It is believed that algorithmic trading, triggered by news stories concerning French President Francois Hollande’s comments on Brexit negotiations, caused a huge drop in GBP.
With little demand on the currency markets at that time for pound sterling, a sudden influx of GBP from automatic selling caused the currency’s value to plummet.
Traders woke up on morning of 21 October 2016 to find GBP to AUD had slumped -2.1 percent, GBP to EUR and GBP to USD had fallen -2.2 percent and GBP to CAD had dropped -2.3 percent. Trading during the European session lowered the Pound even further as fears of a ‘hard Brexit’ continued to mire sterling sentiment.
Has the pound made any attempts to recover?
No currency movement, even the Brexit-battered pound’s, is ever truly unilateral. For the most part the pound keeps tumbling on an initial shock, recovers slightly but remains around the new low, then repeats the process. A series of worrying developments have pushed the pound lower and lower, while positive signs from the UK economy have helped sterling to recover some of its losses, although clearly not by much.
However, one of the reasons the pound has fallen so far is because the markets are largely holding what are known as short positions. A trader who shorts a currency expects it to weaken, so they borrow the currency (the currency is not their native currency) and sell it on the market. Assuming the market moves as they expect and the exchange rate weakens, the trader then buys back the shorted currency at a lower price than they sold it for. They can then return the same quantity of funds to their creditor, keeping the difference made by selling it high and buying it back low.
So the market is currently selling sterling in large quantities, which means GBP is weakening due to the lack of demand amongst investors. However, once the pound reaches what investors deem to be a profitable level, they will ‘close’ their short positions by rebuying the pound. This will create a large demand for the pound, helping it to recover some recent losses.
What is keeping the pound low?
Uncertainty is a currency trader’s worst enemy. The forex market is largely made up of investors looking to make a profit, so the consensus outlook they hold for a particular currency affects its overall value, regardless of the impact from companies and individuals looking to move money for practical purposes.
The fact that Brexit is largely shrouded in uncertainty is therefore keeping investors skittish. While the mass warnings over the negative impact of a Brexit from ‘Remainers’ in the referendum campaign have helped to damage investor confidence, there is also the perception that the ‘Brexiters’ in government still lack a real plan.
The fact that there are so many uncertainties regarding the Brexit means that there is always something waiting around the corner to unsettle markets. Once the initial shock of the vote outcome calmed down, investors were waiting for a solid timeline for the Brexit. When Theresa May announced the formal process would be initiated by the end of March 2017, markets reacted dovishly; many were still holding out hope that the referendum vote would be overturned.
Now that we know we’re definitely heading out of the EU, thoughts have turned to what a post-Brexit Britain will look like. It seems as though the government is intending to choose controlling immigration over single market access, which has again worried the markets due to the implications for the UK economy.
What would boost pound sterling exchange rates?
It is impossible to predict exactly how, when, or even if, pound sterling will recover. There are some key things to key an eye out for, however.
Firstly, monetary stimulus weakens a currency. If it seems like the Bank of England (BoE) is not going to cut interest rates further or pump more money into the economy that will be seen as a sign of confidence in the UK and the pound will likely rise.
There could be strong upside movement for sterling if it seems that the UK will get a favourable trade deal with the EU. Comments from EU politicians suggesting that they are willing to negotiate single market access without freedom of movement would drastically boost investor confidence.
While recent political events have shocked the markets to such an extent that they are largely ignoring key economic reports, UK data will at some point begin to have an impact on currency movement. If enough data suggests that the UK is in a strong position going into the Brexit – for instance, that companies are continuing to hire and invest in Britain and not planning to relocate overseas – the pound could jump.
Anyone needing to move money overseas in the near future should therefore follow the latest currency news to ensure they’re transferring their money at the right time. You might also want to register with a leading currency broker and discuss your requirements with one of their currency experts.
TorFX / Expatica
Published October 2016.
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