Jitters hit sterling as vote looms
The UK government set June 23 as the date for its ‘in-out’ referendum vote on Britain’s membership of the EU and opinion polls are pointing to a very close outcome.
The issue has now moved centre stage in the UK.
It is now a 50-50 call in our view, on whether the UK votes to leave or remain in the EU.
We view Brexit as the main event risk for the UK and Ireland in 2016 as a vote to leave would have profound economic and political consequences for both countries.
However, it is very difficult to quantify the full macroeconomic effects of Brexit.
Crucially, we don’t know what the post-Brexit trade arrangements would be between the UK and EU.
This is a critical question. In order to secure a preferential trade deal, the UK is likely to have to continue to adhere to EU rules and regulations, something it will be reluctant to do.
The more the UK seeks to regain control over policy and regulations after a Brexit, the more difficult it will be for it to negotiate a worthwhile trade deal with the EU.
It would be a major drawback for the UK if it had to fall back on World Trade Organisation rules, which is likely to involve the imposition of trade tariffs.
Some 45% of UK exports go to the EU, so it is a vital market. On the other hand, the UK takes just 10% of EU exports.
Thus, the UK is not as important to the EU for trade as the EU is to the UK.
Brexit would also be a prolonged and complicated process, creating much uncertainty that would impact on economic activity.
Foreign direct investment into the UK would be negatively impacted, especially if there is uncertainty over continuing free trade with the EU.
The EU economy itself is also likely to be negatively impacted.
Sterling appreciated by nearly 20% on a trade-weighted basis between 2013 and mid- 2015, partly fuelled by expectations of UK rate hikes.
The euro fell from close to 90 pence against sterling in 2011 to 80 pence in 2014 and established a trading range of 70 pence to 74 pence in 2015.
A good deal of these gains, though, have unwound over the past four months.
This is largely due to the fact that markets are starting to think about Brexit as something which is now a serious possibility.
The euro has risen by more than 15% against sterling since the start of December, climbing from 70 pence to 81 pence.
Meanwhile, GBP-USD has fallen from a high of $1.59 last summer, to near the $1.40 recently. GBP-USD is now getting close to its 2009 trough of $1.38.
This represents the lowest exchange rate for sterling against the dollar since 1985.
Should the UK vote to remain in the EU, we would expect sterling to recover some of the ground lost recently, rising back up to around 75 pence against the euro, with GBP-USD climbing towards the $1.50 level.
Such a rise in sterling would benefit Irish exporters to the UK.
We don’t see sterling moving back up to last year’s highs, though, of 70 pence against the euro and $1.59 against the dollar, as markets are no longer expecting the Bank of England to raise rates anytime soon.
On the other hand, sterling can be expected to see further losses in the event of a vote for Brexit. This will lead to cheaper imports from the UK, but hit Irish exports to that market.
At a minimum, the euro would seem likely to rise to its 2013 level of around 86 pence.
However, it could well climb to its 2011 high of 90 pence on a disorderly Brexit, where relations are soured with the EU and there are a lot of difficulties in reaching some form of a trade deal.
GBP-USD can be expected to hit 30-year lows on a vote for Brexit, falling to around $1.25, and possibly going even lower on a disorderly exit.
The euro is also likely to lose ground, as Brexit would be seen as a major blow to the EU.
EUR-USD could fall to last year’s low of $1.05 from around $1.14 currently. Thus, the upcoming Brexit referendum will be the key driver of foreign exchange markets this summer.
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