Why Brexit could boost sterling

What would happen to the pound in the event of a Brexit? In the foreign exchange market, there’s always a winner. In a Brexit, that could be sterling.

More than half of the UK public now wants to leave the European Union, according to the latest opinion poll for The Independent.

That’s the first time this monthly survey has shown a majority for Brexit.

Today I want to look at one aspect of a Brexit. What would happen to the pound?

I’ll start with a couple of bet-hedging points.

Forecasting currency movements is ferociously difficult at the best of times. That’s because the foreign exchange (forex) market is a ‘zero-sum game’.

Here’s an example.

Though we might be reasonably confident that a sharp and unexpected rise in global interest rates would hit equity and debt prices across the board, the effect on the forex market could be much less clear.

Unlike with stocks and bonds which can all drop together, if one currency falls then another must automatically rise against it.

In other words, there’s always a winner in forex. In a Brexit, that could be sterling – as I explain lower down.

I must also mention that the effect of Brexit could prove to be hugely overstated.

“Claims that millions of jobs are reliant on membership of the EU are highly misleading”, notes Vicki Redwood at Capital Economics, “as they assume that all the UK’s trade with the EU would vanish if the UK left the EU. In fact, we think that trade with Europe could end up relatively unaffected”.

That said, there’s a very clear consensus amongst commentators that the uncertainty of a Brexit would lead to a fall in sterling.

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Mm… I’m not so sure about this. Why?

First, consensus opinion is usually wrong. So my instincts as a true contrarian are that the pound would eventually climb if Britain were to leave the EU.

Second, the forex market is fully aware of the issues involved, as well as the latest opinion polls.

Granted, sterling has been a bit weak recently against the US dollar, but that’s no surprise: the buck has been the global “go-to” currency for safe-haven investors over the last 18 months.

But compared with the other major players, such as the Japanese yen and – of course – the euro, the pound has been rising.

Put another way, there may be short-term wobbles in the pound around referendum time. Yet international investors clearly aren’t freaked by the prospect of a Brexit.

Third, the UK would save on near-£10bn of annual contributions to the EU. That would be a very nice slice off the country’s budget deficit. It wouldn’t do the pound any harm either.

Fourth, it’s not like the UK would be withdrawing from the euro. By retaining the pound, Britain has maintained a high degree of economic independence.

It has also kept its distance from “eurosclerosis” – a term coined by German economist Herbert Giersch to describe economic stagnation in Europe resulting from government over-regulation and over-generous social welfare policies.

Pulling out of the EU would give the UK more flexibility in its commercial and labour markets. Over time, that could boost economic performance – and the pound.

Fifth – while in my view it’s unlikely – there’s the possibility of tariffs being imposed on future UK/EU trade in the event of a Brexit.

But even if Britain’s trade with Europe were to suffer as a result, these losses could be offset over the long-term by extra opportunities to boost trade with emerging economies.

Again, this could be an eventual plus-point for the pound.

In summary: let’s not panic about sterling and Brexit. In fact, the latter could well give our currency a major boost over the coming years.

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