The British Pound Is Turning Into An Emerging Market Currency
Talking Points:
- Brexit has permanently altered investors’ perspective on sterling, warns experts.
- The British pound has not recovered to levels before the UK voted to leave the EU, losing around one-fifth of its value.
The pound is currently an emerging-market currency all but in name, according to experts at Bank of America, who state that Brexit has transformed it into a reflection of the “small and shrinking” UK economy.
Over the four years since the UK voted to exit the EU, trading conditions in the pound and the large fluctuations in exchange rates make it more comparable to the Mexican peso rather than the US dollar, said a currency expert at the Bank of America. He said that volatility in the Pound since the 2016 Brexit vote has become “neurotic at best, unfathomable at worst.”
The bank’s experts noticed that the difference between rates at which investors are happy to buy and sell the Pound remains larger than in other major currencies, even after the wider market has settled in the aftermath of the Coronavirus outbreak in March.
Implied volatility, a measure of investors’ expectations of the size of future price moves, has also stayed higher in the Pound over other major currencies. BofA said that underlined an absence of clarity over the currency’s future.
Failure to come to a deal on Britain’s future relationship with the EU in the next six months will be “disastrous” for the Pound, said an expert at Lombard Odier Group. Sterling could drop to 1.10 USD or even lower, he said, from 1.25 USD, while the Euro could converge to parity from 0.90 GBP.
An expert at the Bank of America said that “We believe sterling is evolving into a currency that resembles the underlying reality of the British economy: small and shrinking with a growing dual deficit problem.”
Generally, Sterling has been a member of the so-called G5 currency group, with the dollar, the euro, the Japanese yen, and Swiss franc, as one of the most traded and therefore secure currencies in the world.
Following Brexit, the concerns over the relationship between the UK and the EU have made investors skeptical about giving opinions about the currency, resulting in a drop in liquidity. That implies that the Pound can no longer be analysed according to the same structure as other major currencies, advised the expert.
He went on to say “The Pound increasingly resembles the more liquid emerging market currencies rather than a core G10 currency.”
The Pound has not been able to recover its level since before the UK voted to exit the EU, losing about one-fifth of its value. What’s more, since the start of the pandemic, the pound has fluctuated violently. At the peak of the crisis, investors were preparing for massive movement in the Pound.
The Pound tumbled to a multi-decade low against the dollar in mid-March, before rebounding after the US Federal Reserve and other major central banks stepped in to support the dollar.
However, on-off trade talks between the UK and the EU have damaged attitude towards the Pound. The chance of the Bank of England seeking negative interest rates has also halted the currency’s rally, as has the country’s swelling fiscal deficit following a large increase in spending to ease the worst impact of the Coronavirus.
Headwinds are proceeding to build for the Pound given the year-end cutoff for agreeing to the EU trade relationship and the country’s unrelenting current account deficit.
