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Sterling Plummets on Shock Referendum Result

Tuesday 05 July 2016

June proved to be an extremely disappointing month for euro buyers, with sterling losing significant value against the single currency due to the shock outcome of the UK referendum, writes Ben Scott.

Sterling traded the first half of the month within a tight range on the back of conflicting opinion polls, pointing to a close referendum result.

However, with popular opinion suggesting a vote to remain part of the EU would prevail, the surprise decision for the UK to leave, and the immediate uncertainty caused by the result, proved even more detrimental for sterling.

Nevertheless, sterling losses were not as significant as reports from several large investment banks had voiced before the referendum, which gloomily forecast parity for GBP/EUR should the UK vote to leave the European Union.

Sterling reached the highest level of the month on the night of the UK referendum, with GBP/EUR reaching 1.3150 (Interbank throughout) as illustrated by point B on the graph.

However, the surprise outcome pushed sterling significantly lower before GBP/EUR traded at the lowest level for 25 months, hitting a low of 1.1923 (30 June at point C).

GBP/EUR traded at an average rate of just 1.2660 throughout June.


If things had gone to plan Sterling should have started the month on the front foot, as economic data from the UK showed signs of improvement, with manufacturing PMI moving back into expansionary territory, whilst construction and the vital services sector both showed positive improvements on previous months.

However, losses coming into the month can be attributed to the ongoing uncertainty surrounding the referendum with ICM and Guardian polls at this time showing a significant swing in favour of the campaign for the UK to leave the European Union.

Despite better than expected manufacturing and industrial production data, sterling actually lost ground against the euro throughout the first half of the month as political uncertainty continued to outweigh economic improvements.

The horrifying murder of Labour MP, Jo Cox, by a murderer holding far right views, unsurprisingly seemed to swing the vote back towards a vote to Remain.

The belief that this horrible event had tipped the referendum in favour of the Remain campaign saw sterling recover, pushing it to one of the highest levels since Prime Minister David Cameron announced the referendum.

After the result was announced sterling came under significant pressure with credit rating agencies Standard & Poor’s and Moody’s both stripping the UK of its much revered AAA credit rating.

Nevertheless, the warnings of a financial Armageddon from the Remain campaign failed to materialise, with several huge businesses such as HSBC and Barclays pledging to remain and expand in the UK, whilst Chancellor George Osborne rapidly backtracked from a pre-referendum threat that a vote to leave would result in an emergency budget and tax increases.

However, post referendum comments from Bank of England Governor Mark Carney that a deteriorating outlook meant action from the Bank was likely. He stated, “some monetary policy easing will likely be required this summer”, apparently confirming forecasts from several big investment banks, such as UBS, who forecast that the referendum result will see the Bank of England cut interest rates from current levels of 0.5% to 0% by the end of the year.

This resulted in sterling reaching 25-month lows (point C on the graph) as sterling becomes a far less attractive investment.

Outlook

Political uncertainty will remain a key issue for the UK in the coming months, due to the referendum result and the political consequences arising from it.

The Prime Minister David Cameron announced his resignation and there are serious internal divisions within the ruling Conservative Party.

Similar divisions have also arisen within the Labour Party, and in Scotland the First Minister, Nicola Sturgeon, wasted little time in warning Holyrood could attempt to block the UK’s exit from the EU, suggesting a second Scottish referendum should take place on whether to remain a part of the UK.

With the UK facing two years of negotiations surrounding its divorce from the EU, the lack of a strong and robust leadership and clarity surrounding the terms that the UK wish to achieve could prove extremely detrimental to the economy and to sterling.

Conversely, in Europe, despite some improvements in economic data suggesting ultra-low interest rates and other monetary easing policies were starting to have a positive impact on the EU economy, concerns also grow regarding the European Union.

EU member states including Italy, Netherlands, Austria, Denmark, the Czech Republic, Greece and France may well have referendums of their own over the next few years regarding their continued membership within the European Union.

We may well be witnessing the collapse of the European Union in its current form.

Ben Scott
Foreign Exchange Ltd
www.fcexchange.co.uk

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