Brexit: Historic Pound-ing Continues

Last week the British Pound touched a historic low against a basket of global currencies according to the Bank of England. The uncertainty around Brexit has resulted in an almost 18%* decline in the Pound versus the U.S. Dollar since the start of the year, a 31-year low. The process has been volatile, including the 2-minute flash crash. Even more incredibly, the Sterling has been pounded against the Euro by as much as 22%* since the turn of the year.

The majority of this decline has occurred over the last four months, following Britain’s decision to leave the European Union. The decline entered new ground following Prime Minister Theresa May’s announcement that her government would prioritize immigration over access to the E.U.’s single market during the exit negotiations.

While her decision appears to have surprised the currency markets, Brexit voters made it clear that resolving immigration was an area they felt the country could not address while remaining part of the union. The currency decline highlights the uncertainty facing the U.K. economy given 44% of Britain’s goods and services exports went to the EU in 2015.

Notably, the Prime Minister appears to want to establish new trading relationships with a wide range of nations, including China, the world’s second largest economy. Prior to the U.K. joining the common market in 1975, a large portion of its trade was with countries of its former empire, including New Zealand, Canada, Australia, India and South Africa.

The question on many people’s minds is whether this spells a new trend for the Pound or whether the decline is nearing an end. While analysts are split on this topic, it is almost impossible to predict where the bottom will be given the number of moving variables and the complexity of the political decisions still to be made. The recent moves in the currency are likely to attract a large number of speculators which can result in a self-reinforcing trend. Many renowned currency speculators point out that currency trends tend to last at least two years. George Soros, the man who netted US$1 billion betting against the British pound in 1992, believes gold is one way to protect yourself against depreciating currencies.

“Expectations about future exchange rates constitute the main motivation in speculative capital transactions” – George Soros, The Alchemy of Finance

A depreciating local currency brings windfall profits to exporters, but whether they decide to invest these profits back into the economy or not will be key. Unfortunately, during 1985 when the Pound fell below $1.10, exporters did not expand their activities and instead accumulated cash.

“Both an appreciating currency and a depreciating currency discourage physical investment and foster accumulation of hot money” – George Soros, The Alchemy of Finance

On Friday, the Bank of England governor Mark Carney made it clear that inflation will rise following the large drop in the value of the Pound and continued to defend, what some regarded as hasty, the decision to cut rates. He notes that things are “going to get difficult [for those on the lowest incomes] as we move from no inflation to some inflation”.

*as of 16th October 2016