Will the Pound ever recover from a Brexit?

As an in-out referendum on the EU draws closer and influential figures from businesswoman Karren Brady to fund manager Neil Woodford weigh in on the debate, the uncertainty over Britain’s future is being felt on the currency markets. The Great British Pound has dropped significantly against both the dollar and the euro since the start of the year – but what will happen to Britain’s currency if the country votes for a ‘Brexit’?

Last year’s Scottish referendum gives us some clue as to how the Pound may be affected. In the run-up to the election the Sterling exchange rate sank as the fate of the UK appeared unstable, with the pound falling nearly 4 percent against the dollar over 10 days. As uncertainty takes hold, the exchange rate is likely to do the same in this referendum, seeing significant volatility – as we have already started to see.

If the UK votes to leave the EU, the exchange rate will undoubtedly be affected by whether or not the UK’s economy can hold up on its own. The latest figures from Open Europe estimate of the impact of Brexit ranging between the UK being 2.2 percent of GDP worse off in 2030 if it leaves and reverts into protectionism; to UK being 1.6 percent of GDP better off in 2030 if it leaves and pursues economic liberalism. It continues:

“In reality, the UK may fall somewhere in between, with the most realistic scenario ranging from -0.8 percent of GDP to 0.6 percent. This means that Brexit is a more finely balanced calculation than most previous studies have concluded.”

So, should the UK’s economy be relatively unaffected by the exit, rates could recover relatively quickly. However, if our economy takes a hit, we’re looking at a longer period of volatility. Whatever the case, in the immediate aftermath, Pound Sterling or the Euro exchange rates would be likely to sink and may remain vulnerable for some time. Bank of America Merrill Lynch has recently published a warning over the Pound’s rate should the UK vote to leave, especially in the short term:

“In our view there would be serious economic fall-out for the UK in the short- and long-term if voters choose to leave the EU. Many contingent factors are likely to play a role: any exacerbation of refugee issues could help ‘pro-outs’, while any strengthening in the European economic recovery may support ‘pro-ins’.”

It is clear that, whatever the result of the referendum, the Pound is entering a period of uncertainty – which may be severe enough to require the Bank of England to introduce fresh stimulatory measures, as opposed to raising rates like the Federal Reserve. The industry as a whole seems to be bracing itself for a volatile period – Standard and Poor’s have changed its sovereign credit outlook on the UK from stable to negative, while the Confederation of British Industry cut its 2015 growth forecast from 2.7 percent to 2.4 percent – both of whom said uncertainty over the referendum was a deciding factor.

Miranda Wadham on 18/02/2016
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