The Brexit countdown is on with little more than a month to go before Britain exits the European Union (EU), with or without a deal. However, the Brexit issue has been ongoing for more than two years now, and the British pound (GBP) has suffered as a result.
Not only has the GBP’s value fallen and remains lower than before the Brexit vote, trading volumes for the currency have also dropped. In terms of trading volume, over the past year, almost every single major currency managed to increase their market share, except for the sterling.
Lower Liquidity has Lead to Overreacting GBP
According to a report from Reuters, many market participants have attributed reduced liquidity as one of the main reasons why the GBP has become vulnerable to increased volatility, with the market appearing to react dramatically to relatively minor events.
Speaking to the news outlet about turnover on Nomura’s platform, Fabrizio Russo, head of foreign exchange sales for Europe, the Middle East and Africa said: “A lot of people… have increased exposure (in recent weeks) though sterling volumes are about 40-50 percent lower than pre-Brexit roughly on an average.”
In London, the USD/GBP pair is still the second-most traded exchange rate, however, trading volume has declined. According to data from the Bank of England (BOE), the average daily volume for the six months ended October 2018 dropped to $324 billion from $351 billion in the previous six-month period ending April 2018.
Furthermore, over the past four years, whilst the currency market has expanded, the GBP’s market share has stagnated and even fallen against some currencies. Looking at data from the BOE, the share of GBP/USD exchange rate fell to 12.4 percent in October 2018, which is a year-on-year drop of 0.5 percent. EUR/GBP fell to 2.5 percent, which before the Brexit referendum, was at 2.6 percent.
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Because of the increased volatility of the GBP, institutional investors and companies have shifted towards the currency forwards and swap markets, rather than cash markets to execute their currency needs, the report from the news outlet said, citing a Head of Trading at a European bank in London.
GBP Makes a Comeback in 2019
However, it’s not all doom and gloom for the GBP. Although trading volumes in 2018 were down, so far this year the currency has attracted healthier trading volumes. This has largely been fuelled by expectations that a Brexit solution will be achieved.
CLS, a foreign exchange (forex) trades settler, had an average daily volume in the GBP of $65 billion in January. This is up from $64 billion in the December quarter and up from the September quarter, which had a volume of $60 billion. It’s also higher than last year’s average of $62 billion.
Nonetheless, it’s still down considerably when measured against the volumes achieved before the Brexit-referendum, where daily average volumes could reach as much as $100 billion.
The uptick in trading volumes also came in the same month as the Brexit vote, where UK Parliament rejected Theresa May’s proposed deal. In the lead up to this, as Finance Magnates reported, many brokers warned their clients to be wary of trading GBP assets, as large swings were expected, which could have further driven traders away from the currency.
“The (recent) rise in volume probably reflects the tension between a fundamentally undervalued currency and the uncertainty surrounding or need to hedge the Brexit outcome,” explained Erik Norland, a senior economist at the CME Group to Reuters.
Trading volumes in the GBP could also further increase in 2019 if expectations of an economic rebound continue and the currency remains undervalued. This would likely result in more participation from mutual funds and central banks, who have pulled away from the volatile sterling.