FX: Sterling volatility here to stay as referendum countdown begins

By:
Solomon Teague
Published on:

The announcement of the referendum date of June 23 on UK membership of the European Union (EU) sent an already-weakening pound into a tailspin, which saw it testing multi-decade lows, but traders are divided on whether sterling has bottomed out as Brexit fears jump.

The Bank of England (BoE) monetary policy committee’s decision to keep rates at record lows contributed to a torrid week for sterling, but on this occasion it was the prospect of a British exit (Brexit) from the EU that was on trader’s minds as they frantically offloaded sterling.

Win_Thin-160x186
Win Thin, BBH
GBP/USD fell to 1.4083 – its lowest rate since January 2009 – as part of a broad weakening that has seen the pound depreciate against almost all major currencies. This caps a period that has seen sterling fall by 10% against the euro since November, leaving EUR/GBP at its highest since December 2014.


This sterling sell-off comes despite the fact the euro is also being dragged down by Brexit fears, though to a lesser extent than sterling.

Traders are bracing for more of the same in coming weeks and months.

Andy Scott, economist at HiFX, says: "Risks now exist for GBP/USD to test towards 1.35, the low we saw after the financial crisis in 2009 and a historically important level."

The 1.35 barrier is significant, he says, because it is the lowest GBP/USD has been since 1985 – and was the level at which sterling stopped falling after the financial crisis, when the pound collapsed by more than 30%.

Scott says: "Sterling is starting to look slightly undervalued and would expect it to find good support at 1.35, limiting further declines."

Bill McNamara, technical analyst at Charles Stanley, says although sterling appears to be oversold relative to the euro, there appears to be scope for further weakness, adding: "A retreat to around €1.25 looks possible before too long."

Win Thin, global head of EM strategy at Brown Brothers Harriman (BBH), is less confident about making such projections. "It is too early to try to pick a bottom in sterling," he says.

Decline welcomed

The BoE appears relaxed, though it would presumably be more comfortable with a more gradual decline.

It might privately welcome the decline in sterling since it will help lift import prices and put upwards pressure on the consumer price index, though it will be several months before the impact of weaker sterling is felt in the inflation figures – assuming it is sustained – and even longer for it to impact trade. Publicly, however, it is remaining neutral.

Société Générale research suggests the news that Boris Johnson, the popular London mayor, has aligned with the Brexit cause accounted for the severity of sterling’s sell-off.

"The Brexit camp has been split largely between the 'vote leave’ and 'grassroots out’ groups," it says. "Thus, the possibility of a popular unifying figurehead for the Brexit campaign would be a huge game-changer."

Others point out it is not only sterling weakness but dollar strength that has contributed to extreme moves in that pair specifically.

Nicholas_Laser-Ebisch-160x186
Nicholas Laser-Ebisch,
Caxton FX

That particular rate will continue to be determined as much by US data as by UK political concerns, says Caxton FX analyst Nicholas Laser-Ebisch, though sterling strength more broadly "will likely depend on the information that is presented in the next four months as to whether or not the UK will exit the EU". 

As such, while recently the 'leave’ campaign has dominated the headlines and sterling has therefore suffered, any perceived victories ahead of the vote by the 'remain’ campaign – favourable polls or reputable businessmen coming out in favour of staying in Europe, for example – might lead to similar sterling gains.

"The story is likely to flip from either side over the next few months, so I wouldn’t expect the move in sterling to be one way," says James Hughes, chief market analyst at GKFX, the online broker.

HiFX’s Scott draws parallels with sterling volatility in the months leading up to Scotland’s independence referendum, adding: "As we approached the vote, the polls began to have a greater impact on sterling with it falling sharply due to a narrowing of the lead of those voting to stay part of the UK."

Laser-Ebisch at Caxton cautions sterling moves might feel quite random as sentiment is pulled in different directions by various commentators on Brexit.

"We will likely see exchange-rate swings of up to 5% in the next four months," he says, having already witnessed moves of 6% and 8% in GBP/USD and GBP/EUR, respectively, this year.