This guest article was written by Ronnie Chopra who is the Managing Director of City Trading Academy.
Concerns over whether Britain stays within the European Union (EU) or not have hurt the pound sterling, pushing the GBP/USD below $1.40 for the first time since 2009. The sharp decline in the pound means that the GBP is the worst performing major currency against the USD thus far in 2016.
The breach below the psychologically important $1.40 has largely been avoided since the mid-late 1980s – in this instance, the GBP/USD plunged all the way down to below $1.05 during February 1985, making the UK an extremely popular tourist destination for visiting Americans, but the US an extremely expensive one for British visitors.
HSBC analysts have also echoed a cautionary tone, warning that lingering uncertainty over a Brexit would grip the economy and “take 1.0-1.5 percentage points off the GDP growth rate by the second half of 2017”. The bank has predicted that the GDP growth rate would fall from the current 2.3 percent forecast to 0.8 percent to 1.3 percent.
If the GBP were to fall by 15-20 per cent as analysts predict, UK inflation could rise by up to 5 percentage points. The sharp rise in inflation would be due to the much higher cost of imported goods. An inflation rate of 5 percent would be extremely damaging for the UK economy as goods and services would become much more expensive and there would be less personal disposable income for individuals. It has been said that a 4 percent fall in sterling boosts inflation by 1 percent.
The pound has also faced increased pressure this week amidst concerns about the EU referendum with London mayor Boris Johnson giving support to the ‘Out campaign’. This has acted as the catalyst in driving the pound even lower. Johnson in particular is seen as a big boost for the Brexit campaigners as he is one of the most recognised politicians in the UK and is popular amongst the UK electorate. The likelihood of a vote to leave the EU has now risen to 40% since London Mayor Boris Johnson has come out in favour.
It is now not only the Brexit situation that is causing the pound to fall further, but also news that the Bank of England Governor, Mark Carney, has said that rates could be cut in the UK in the future. The Bank of England has also alluded to the fact that it is open to fresh stimulus if economic conditions deteriorate over coming months and this has weakened the pound further.
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Investors are worried about the UK’s economic prospects if it leaves the EU and they are more reluctant to hold assets in sterling. Even before the outcome of the referendum is known, businesses do not like uncertainty and investment and growth could be detrimentally impacted.
Markets continue to place little chance of an interest rate rise until 2018 ensuring that the pound finds little support from interest rates. Higher interest rates attract capital from across the world as investors look for high yields but talk of lower interest rates is causing the pound to fall further.
A British exit from the European Union could also push sterling sharply lower – 29 out of 34 economists in a Bloomberg survey see it falling to $1.35 or below within a week of a vote to leave – these were the levels in 1985. Goldman Sachs has also said that the currency may fall 20 percent on Brexit and sink as low as $1.15.
The pound is at its lowest level against the US dollar since March 2009 and at its lowest level for more than a year against major currencies such as the euro and the yen. The uncertainty and disruption of an Out vote would hit UK growth, interest rates would remain at record lows for longer, meaning a lower return for holding sterling. Some investors would sell UK assets and pull out of the country. These capital outflows would also weaken the pound.
Ratings agency Moody’s has also warned that Britain’s strong credit score would be at risk if the British public vote to leave the EU on 23 June. A lower credit rating would mean the UK having to pay more to borrow, which would make it harder for the Chancellor of the Exchequer to meet deficit reduction targets.
An even weaker pound due to Brexit would however boost tourism in the UK with the fall in the pound providing a massive boost. Unfortunately, foreign holidays to the US would conversely be much more expensive. British exporters would be given a massive boost as our goods would be much more competitively priced abroad but the increase in the price of imports would boost prices and inflation. Swings and roundabouts!