Brexit, Schmexit! Part 1: The Pound

After recent negotiations between the UK Prime Minister and heads of EU states, the in-out referendum has been scheduled for June 23rd.  So far, Brexit has been hogging air time across news outlets all over the UK.

Brexit stands for British Exit of the European Union.  Over the next 3 months I will bring you a series of blog posts analyzing Brexit and its implications to the UK economy, starting with the pound.

The Pound

The main focus of markets during last week has been a relentless downward pressure on the Pound Sterling (GBP).  The Quid reached 2008-2009 recession levels against the US Dollar (USD), which has been raising in value on its own steam for the last few months.  The Sterling also lost ground against the Euro (EUR) and the Swissie (CHF), although not nearly as much as it did against the Dollar.

Why has this happened? I believe it to be an irrational reaction by the markets, who simply don’t like uncertainty.  Because that is all there is: uncertainty.  There is no underlying fundamental reason to assume that if and when Britain leaves the EU investment or trade will be reduced, or that the balance of payments or current account will change dramatically.

The uncertainty stems primarily from the fact that this has never happened before.  No country has ever left the union, and therefore there isn’t a plan, blueprint, chapter in the book, set of rules and regulations, clauses, or guidelines that explain how to proceed in such an event.  And that spooks investors.

Britain is the fifth largest economy in the world by GDP on its own right, and while the EU is its largest trading partner and it has a negative trade balance with them, which means that the EU sells more to the UK than the UK sells to them.  I don’t believe the UK will have a problem signing trade agreements with the EU countries, or even signing more favorable agreements with non-EU countries once they is not covered by the blanket free-trade agreements signed by the EU as a whole.

For even if the UK voted to exit the EU, foreign trade will not come to a halt.  All trade will have to continue under the current agreements, until official exit plans are drawn (remember such plans don’t exist under the current EU bylaws).  The UK would then need to negotiate one-to-one or one-to-many trade agreements with different countries around the world, and this process could take up to two years.

Although some analysts call for a parity between the Pound and the Euro as a result of Brexit, I wouldn’t expect any dramatic long term effects.  There will be wild fluctuations in the interim as a result of speculation, uncertainty, and general nervousness but unless the fundamentals change I see no reason for the volatility to hold beyond June.