Why Does a Hard Brexit Scare GBP Bulls Away?

The GBP/USD currency pair has whipsawed wildly this week. The current exchange rate is 1.2285, down 0.94%, but this was preceded by a sharp gain on Tuesday, 17 January, from a level of 1.2046 to 1.2414. The GBP has been the worst performing G10 currency since the ill-fated Brexit referendum on June 23, 2016. The pound plunged to a 31-year low against the greenback, then proceeded to consolidate in a tight trading range around the 1.20 – 1.23 level. That the GBP has found fresh weakness against the greenback is a testament to the anxiety generated by Brexit proceedings. At the heart of the issue is the nature of a Brexit.

Brexit Matters – Trading Barbs About a Hard and Soft Brexit

A ‘Hard Brexit’ is characterized by a sudden break from the European Union, while a ‘Soft Brexit’ is categorized as a gradual extraction from the single trading bloc. Naturally, markets prefer the latter option since it involves the establishment of frameworks and relationships between the UK and the EU. When delivered her speech on Tuesday, 17 January 2017, she laid out her 12-point Brexit plan. She made it clear that Britain would indeed be pushing for a Brexit as soon as possible, but the final status would be put before Parliament in a vote. This is the reason we saw a sharp appreciation of the GBP against the USD, the EUR, the JPY and others on Tuesday. However, by Wednesday, 18 January the sentiment soured and the GBP went on the decline.

What Effect Is a Weak GBP Having on the UK Economy?

The GBP is inversely correlated with the FTSE 100 index. We are seeing some interesting developments taking place in the stock market with the predominantly offshore-based earning potential of the FTSE 100 index. Since most of the FTSE 100 index companies derive their revenues from abroad, the repatriated earnings are worth significantly more in GBP. Every time the GBP/USD pair depreciates, or the EUR/GBP pair appreciates, the GBP share price of companies on the FTSE 100 index rises. This gives the impression that the FTSE 100 index is performing strongly. Truth be told, the FTSE 100 index has not performed all that well in dollar terms. Mining stocks have helped to push up the UK index, and US fiscal policy aspirations are driving up sentiment on Britain’s blue-chip index.

During 2016, the FTSE 100 index increased by £232 billion, up 14.4%. This was the best yearly performance of the index since 2013. The real shock is evident in the performance of the FTSE 100 index in USD. When evaluated this way, the FTSE 100 depreciated by 5% in 2016. Some 70% of revenues generated on the FTSE 100 index come from abroad, but businesses with 70% of their revenues in the UK reported a decline of 6%. This is telling, and it is evident in the FTSE 250 index which generates most of its money in the UK.

On a Domestic Level, How Are Britons Faring?

The acted swiftly to quell fears about a Brexit when it reduced the interest rate by 25-basis points. The UK interest rate is now at 0.25%, a record low for Britain. When the Bank of England Monetary Policy Committee (MPC) unanimously voted to maintain interest rates at 0.25%, it also continued purchasing assets valued at £435 billion. The goal of course is an inflation target of 2% so that employment and growth can be supported.
This bodes well for homeowners seeking to apply for mortgages and for everyday Britons seeking from British banks and credit card companies. The ubiquity of low interest credit is assisting the folks at home. The Bank of England is expecting inflation to hit 2%, and this is entirely possible if the velocity flow of money through the UK economy can accelerate and prices can start to rise. A weak GBP has positive spinoffs, not least of which is better export potential for the UK economy.

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