Brexit and the Pound

December 3, 2018

Since the UK voted to leave the European Union on the 23rd of June 2016, the value of the pound has been subject to sustained uncertainty and volatility. With £1 previously trading for over $1.50, the Sterling-Dollar exchange rate now sits at just $1.28, having collapsed in value on certain trading days in response to shock events and also undergone more gradual appreciations and depreciations in response to a shifting Brexit narrative. This article will examine key events thus far that have affected the value of the Pound, likely future trends in the currency’s value in the context of Brexit and the resulting implications for businesses, consumers and the economy as a whole.

The close fought nature of the referendum campaign was reflected in movements in the pound’s value between April and June 2016, with the pound initially climbing from $1.42 to peak of $1.47 amid confidence of a remain vote, before shedding these gains as it depreciated to $1.41 in early June amid greater uncertainty over the expected outcome of the vote. The collapse in the value of Sterling following the referendum outcome on the 24th and 25th of June continues to be the most significant shock to the pound in the Brexit saga so far; in 2 weeks, the pound depreciated by nearly 12% from $1.46 to $1.29. This fall in the currency’s value reflected uncertainty amongst investors over the economic impacts of Brexit in terms of the future trading relationship of the UK and EU, the timescale over which Brexit would be delivered, and the aims of the UK in the upcoming negotiations.

 

A slight appreciation following Theresa May winning the Conservative leadership contest and becoming Prime Minister was reversed after she elected to trigger Article 50 in March 2017, formally setting in process the mechanism by which the UK is to leave the EU and imposing a 2 year deadline on extremely complex and fractious negotiations over the Withdrawal Agreement and Political Declaration. Investor concerns about the economic implications of the political situation in the UK increased into the Autumn of 2016, with Scottish First Minister Nicola Sturgeon reigniting concerns about the breakup of the UK with calls for a second independence referendum for Scotland. All 32 council areas of Scotland voted to remain, with an aggregate vote split of 68% to 32% in favour of the UK continuing its membership of the EU.

 

Donald Trump’s victory on the 9th of November 2016 in the US presidential elections saw an increase in the Sterling-Dollar exchange rate to $1.24, although this was likely a reflection of concerns about future US economic policies rather than a vote of confidence in the ability of the UK government to deliver an orderly or successful Brexit. In particular, Trump's rhetoric regarding a trade war with China, withdrawing from NAFTA and pursuing an ‘America First’, isolationist approach to foreign policy concerned investors, as did demands that US multinational companies do more to relocate production to the US and reduce their manufacturing activities in low wage east Asian economies.

 

The Pound made a reasonable recovery through to mid May 2017, with Theresa May calling a snap general election with a view to increasing the commons majority of the Conservatives. The reasoning here was that with a sizeable majority in Parliament (which appeared a likely outcome of the election given polling data and Corbyn’s apparent unpopularity both amongst his own MPs and amongst the British public) would give her a strong mandate to negotiate her vision for Brexit. The loss a parliamentary majority for the Conservatives and resulting reliance on the DUP through a confidence and supply agreement plunged the UK into further political turmoil and saw the Pound slide 8 cents in terms of the Dollar to $1.27.

 

Progress through the remainder of 2017 in Brexit negotiations, with the Department for Exiting the European Union and the role of Brexit Secretary being created, Chancellor Philip Hammond setting aside £3.7bn for preparations for Brexit and agreements over the UK’s financial ‘divorce bill’ of £35-39bn caused the Pound to appreciate against the Dollar to $1.34 in early December. The approval by EU leaders of a text on trade, security and other areas as well as the the Bank of England raising the UK base rate from 0.25% to 0.5% led to a significant increase in the value of the Pound through into Spring 2018. The Bank of England’s decision to fractionally raise interest rates was made with a view to controlling inflation (driven in part by the Pound’s post Brexit depreciation), with the CPI inflation rate reaching 3.1% in November 2017.

 

Increasing fears, especially by businesses, of the potential for a so called ‘hard Brexit’ or ‘no deal’ Brexit, fuelled by the argument of Theresa May and others that ‘no deal is better than a bad deal’ led to a sustained depreciation of the Pound in terms of the Dollar between April and June 2018, reaching a low of $1.33. Jaguar Landrover, the UK’s largest car manufacturer and employer of 40,000 highlighted the impact of Brexit related uncertainty on investment in the automotive sector, stating that “Brexit has derailed the industry”. The firm also announced that it plans to cut 1,000 jobs due to the impacts of Brexit on its supply chain, costs and profitability. Other multinational companies including BP, BMW and Nestle went on to warn that they too could cut jobs or withdraw investment from the UK if the government didn’t provide more clarity about the likely terms of the UK’s exit from the EU.

 

Through the Summer and Autumn of 2018 the value of Sterling relative to the Dollar has continued to fall, reflecting an increasing pessimism by investors that the multiduous paradoxes and conflicts that permeate the issue of Brexit can be reconciled and resolved. The issue of a backstop mechanism to prevent a hard border between Northern Ireland and the Republic of Ireland under any scenario (which it is thought could jeopardise the peace brought by the Good Friday Agreement) has proved particularly contentious. With the UK and EU struggling to find a solution that respects the desire of the EU to maintain the regulatory integrity of the Single Market and Customs Union and the UK’s desire not to see different parts of the Union subject to different laws, trade policies and regulations, fears have increased about the potential of a no deal Brexit.

 

With the Pound valued at just $1.27 in August, there seemed to be the potential for the UK to withdraw from the EU on the 29th of March 2019 in a highly disorderly manner that risks planes being grounded, shortages of essential goods such as food and medicine in the UK, issues regarding the movement of people at borders and thousands of lorries parked along the M26. In response to real concerns about the potential for such a scenario to cause severe damage to the UK economy, the government published a series of notices to businesses on preparations they can make for a no deal Brexit.

 

In the context of the Liberal Democrats, led by Vince Cable, as well as Labour figures such as Sadiq Khan and even Conservative MPs calling for a People’s Vote on the final deal and talk of Conservative MPs from the eurosceptic European Research Group triggering a vote of no confidence in Theresa May in the hope of reshaping the Brexit deal, the government’s success in reaching a Withdrawal Agreement with the EU on the 14th of November saw the Pound valued at $1.30.

 

Since then, the political and economic turmoil has continued, with many arguing that its is arithmetically impossible for the Withdrawal Agreement to be voted through Parliament in the upcoming ‘meaningful vote’ on the final Brexit deal. With Labour, the SNP, Liberal Democrats and right wing Conservative MPs as well as the DUP all potentially set to vote against the deal, Brexit Secretary Dominic Raab (himself a replacement to David Davis who also resigned) and Esther McVey resigned from the Cabinet. Cabinet resignations, talk of a leadership challenge to Theresa May and the probability of the deal being rejected by Parliament has led to the Pound depreciating to just $1.28.

 

Both domestic and foreign investors look set to continue to struggle with considerable uncertainty regarding Brexit, which will lead to continued volatility (and on balance weakness) for the Pound. With a second referendum, a no deal Brexit, an extension to the transition period, a general election or a Conservative leadership contest all remaining potential future scenarios, there continues to be a real lack of clarity about what shape Brexit will actually take and what this will mean for the UK economy.

 

If Parliament approves the Withdrawal Agreement and work continues through the 21 month transition period to create a deep and bespoke free trade deal between the UK and EU, then there is potential for the UK economy to recover some momentum and for rising investor confidence to see the Pound return to nearer its $1.50-$1.60 valuation before the Brexit issue arose. Under such a scenario, a more stable exchange rate should increase business confidence to invest in the UK, make the Bank of England’s task of controlling inflation easier, and reduce price volatility and input cost volatility for consumers and firms.

 

If, however, any of the other potential outcomes come to pass, there is the potential for further depreciations in the Pound, especially under a poorly managed no deal outcome. This would lead to further inflationary pressures for consumers and firms that must be managed by the Bank of England and an erosion of living standards for a UK population dependent on imported goods. In the long run, a permanently weakened pound would increase costs of production for UK firms, making them less profitable and acting as a considerable drag on the UK’s already sluggish economic growth. With reduced real wage growth, less profitable firms creating fewer jobs, and reduced investment into an isolated and conflicted Britain, Brexit still has the potential to wreak the economic havoc that David Cameron and George Osborne predicted during the 2016 referendum campaign.

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