Brexit: will we see a rush against the pound?

With all the uncertainty created by the EU referendum, many people suggest we will see selling pressure on the pound. Will the vote be a sword of Damocles?

Much like the North Pole in summer, the sun never sets on the foreign exchange market.

Because it’s a decentralised market, currencies are being traded in every corner of the world, from London to New York to Tokyo.

The foreign exchange market is the most liquid of all the financial markets with over £3 trillion being traded every day.

And though you probably know already, currencies are always traded in pairs, so their value is defined by the other currency.

This is important because it means that it’s impossible for one currency to become stronger without another becoming relatively weaker.

Remember that.

Indeed, today we’re going to look at what the prospect of Brexit might do to the value of the pound.

Many people suggest the EU referendum will create selling pressure on the pound, which will mean its value decreases.

Why?

Well, mainly because of all the nervousness that’s about over the outcome and the uncertainty of what a Brexit might actually involve.

But, as I say, for one currency to go down, another must go up.

So, a key variable to look at would be the pound’s relative position to the euro at the time of the vote.

As it currently looks like the pound will be stronger, a rush against the pound in advance of the poll seems entirely possible.

And for the same reason you may sell a stock at a high price when you anticipate a drop in its value, it could well be an opportunity to sell the pound.

Parallels are being drawn with the Scottish independence referendum in 2014. When polls narrowed and even briefly showed a majority supporting Scotland breaking away from the UK, sterling dropped 4% in just ten days.

It’s difficult to predict at this stage but the EU referendum is generally expected to be a close vote. Uncertainty is therefore likely to mount the closer we get to the ballot. Especially if it ends up being a toss-up.

My colleague Tom Tragett, editor of Forex Insider Daily, shares these concerns…

Of course, Tom is much too experienced to approach this as a black-and-white issue. There are simply too many ifs and buts to say anything with certainty.

But Tom does note that there’s been a huge increase in capital investment from the EU as well as from countries like China and Japan into the UK in the past years. So, he says:

“If they [investors] feel that they could be at risk of losing their investment or even outbound business from the UK into the Eurozone then they might initially take drastic and evasive action to hedge against such a potential.”

Simply put, if Britain appears to have one foot outside the EU’s door, then these investors are likely to take precautionary measures.

No one can say if they will actually leave the UK, and there are reasons to believe they won’t. But in case they do they will want to have their suitcase packed and ready to go.

Something to think on.

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Elsewhere, another person who soon has to pack his suitcase is DR editor Ben Traynor.

Ben dropped me a note from Nicaragua, where he’s been meeting with Jim Rickards and other editors from our Agora offices worldwide:

nica

Here’s what he sent me:

Hi Pieter

Just been speaking with Jim about Brexit and the implications for sterling, which I know you’re writing about this week. He made an interesting point that the SDR rebalancing’s likely to take place at roughly the same time as any Brexit-driven sterling weakness. [Pieter’s note: SDRs are special drawing rights, a kind of quasi money issued to countries by the International Monetary Fund. Glenn wrote a primer on this earlier in the year, which you can read here].

The expected timetable is they’ll announce the new SDR weights at the end of March, to go into effect end-September. The pound’s almost certain to lose a good chunk of its weighting to make room for the Chinese yuan. This is likely to create sizeable selling pressure on sterling as major institutional investors rebalance their portfolios (there are some big funds that seek to mimic the SDR weightings in what they hold in order to reduce exposure to currency moves, so they’d want to sell sterling-denominated assets).

So you could get that selling pressure at the same time as Britain’s debating whether to leave the EU and the uncertainty that that creates.

The SDR angle is independent of the Brexit debate but both could well prove to add some short run selling pressure on sterling. It’s a very nuanced picture as Jim was keen to stress, but definitely one for us to watch closely in the New Year.

An interesting note from Ben.

Indeed, the nearer we get to the vote, the EU referendum may prove to be a sword of Damocles lingering over the pound.

Now, at this point there’s no way to determine if that sword is ever going to drop. It’s not even sure, were it to drop, it would do serious damage.

But, people being people, their instincts may tell them not to hang about directly under that sword.

So, as Strategic Intelligence editor David Stevenson also told me, “there may be short-term wobbles in the pound around referendum time.”

But his outlook on the matter is much less bleak. According to David, sterling could even thrive if Britain left the EU, particularly in the long run.

He’ll explain why he sees an upside for the pound in the event of a Brexit in tomorrow’s DR. Keep an eye out for it.

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