Sterling to rebound if Remain vote wins

This article is part of
EU Referendum – May 2016

Sterling to rebound if Remain vote wins

Currencies are always a tricky instrument and sterling is no exception, with concerns about the outcome of next month’s EU referendum having weighed on the pound’s performance.

Sterling has declined 6 per cent against the euro for the year to date to May 17, while the currency has slipped almost 2 per cent against the dollar in the same period, data from FE Analytics shows.

However, it has had its ups and downs, with HiFX economist Andy Scott noting that sterling’s recent rally of more than 1 per cent against the euro and the dollar had only been “marginally” affected by weaker-than-expected inflation figures released in mid-May.

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Mr Scott explains: “Consumer prices rose at a slower pace last month, which is likely to keep interest rates lower for longer, typically making a currency less attractive. But sterling was buoyed by two EU referendum polls [on May 16] that showed a healthy nine-point lead for the Remain camp, with the odds of the UK staying now around 70 per cent, according to some bookmakers. This helped sterling to recover from a three-week low against the US dollar, and hit a two-week high against the euro.

“With just over a month to go, there seems to be a little more confidence in terms of the outcome, which is leading to more buying interest in sterling. Nevertheless, taking account of the margin of error in polling and the number of still-undecided voters, nothing should be taken for granted and protecting against the potential for significant volatility should remain a priority for businesses and individuals with currency exposures.”

Sterling and Brexit: Expert view

Neil Williams, group chief economist at Hermes Investment Management, comments on the threats to sterling if the UK votes to leave the EU:

“Our inflation simulations suggest a fall in the pound to $1.20 from June would push the consumer prices index [CPI] back above the Bank of England’s [BoE] plus 2 per cent target by [2017]. In our base case [no Brexit], the CPI does not breach 2 per cent until 2018. Further sterling weakness would bring this 2 per cent forward to November 2016, leading to 2.5 per cent before next spring. But we doubt it would trigger a BoE rate hike, given Brexit’s feared hit to growth.

“With rate hikes deferred, short-term conventional gilts may benefit initially, especially on a hard exit. But this could be short-lived, given about one-third of the £1.3trn gilts outstanding is backed by international investors sensitive to currency and ratings risks, particularly if Brexit reignites the risk of Scotland breaking from the UK.

“In which case, it’s possible that dealing with Brexit and a hit to growth may need the BoE to again be a sponsor of gilts, via quantitative easing – potentially intensifying the pressure from lower-for-longer yields on pension schemes.”

Uncertainty over the referendum result means that sterling has been one of the worst-performing major currencies this year, notes Archie Tulloch, investment analyst at Argonaut Capital.