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  1. Home
  2. / Markets
  3. / Currencies

'Brexit' and the British Pound: How Low Can Sterling Go?

Too big and too sudden devaluation would spook investors.
By ANTONIA OPRITA Feb 22, 2016 | 08:00 AM EST

When I pointed out in an article last year that the closer the referendum on whether the U.K. should stay in the European Union gets, the more volatile markets will become, some critics dismissed that forecast as scaremongering.

This morning, the pound is down 1.5% on the session vs. the U.S. dollar and down more than 1% vs. the euro, as the outcome of the referendum, set for June 23, is less and less clear. For a long time, investors, perhaps complacently, believed that when push comes to shove, the British people will vote to remain in the EU.

That is still a strong possibility, but the fact that the charismatic mayor of London, Boris Johnson, threw his weight behind the "leave" group makes things more complicated. Cynics say Johnson's move has less to do with his convictions and more to do with his desire to play the euroskeptic card to become the next leader of the Conservative Party.

Whatever his reasons, Johnson is a heavyweight on the political scene and his presence in the "leave" camp gives it more clout. Opinion polls are almost evenly split between those wanting to stay in the EU and those wanting to leave, heightening investors' nervousness.

With North America (mostly the U.S.) holding the highest percentage of U.K. shares that are in the hands of foreign investors, interest in what happens in the Brexit referendum is on the rise, as uncertainty mounts.

The pound lost 3% of its value since the beginning of the year and is the worst performing developed market currency so far in 2016. Over the past week, the pound weakened by almost 2% vs. the dollar, the worst performer in the G10.

Source: Societe Generale

A weaker pound is not necessarily a bad thing for the U.K., provided the slide doesn't get out of the control.

At the height of the financial crisis in 2008, the Bank of England demonstrated that it was willing to put up with quite a big devaluation without intervening. At the time, the pound weakened by 25% vs. the euro and by a whopping 30% vs. the U.S. dollar.

As the pound weakens, not all is gloom and doom. Exporters would certainly welcome such a development, as it makes them more competitive, and foreign investors will see that their currencies go further in the U.K. market.

Too big and too sudden devaluation, however, would spook investors. So keep an eye on what analysts expect in order to get an idea of what is "normal."

James Knightley, ING Bank's U.K. analyst, expects further downside for the pound over the coming months, saying that there is a 3-4% Brexit risk premium. He forecasts a trading range of $1.30-$1.35 for the pound vs. the U.S. dollar before the June 23 vote.

Analysts at Capital Economics, the London-based think-tank, expect the pound to trade at $1.30 at the end of this year and at around $1.30 for next year, too, as fears of a "Brexit" bring to the fore the U.K.'s gaping current account deficit, which is now around 4% of gross domestic product.

For investors willing to bet that the referendum will decide that the U.K. remains in the EU, the current volatility, coupled with the pound's weakness, might be an ideal opportunity to stock up on cheap U.K. shares.

One particular sector that might be worth looking at is the beaten-down commodities sector, as besides the weak currency and heightened volatility, the low commodity prices could bring up huge bargains. But that is really a brave, risky bet. Just like a British decision to leave the EU would be.

For more on currencies:

  • Don't Be Fed Fooled; Rates Could Rise in March
  • China's Loans Surge, Proving the Doomsayers Wrong
  • Sometimes, a Debt Crisis Doesn't Work Out as Planned
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TAGS: Currencies | Markets

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