Brexit: What Will it Mean for Exchange Rates?

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There’s a lot of confusion around exactly what’s happening with Brexit, which seems to be more and more complicated. Whatever you think is the best solution, if you’re in business you’re likely to be facing difficulties because of all the uncertainty. How can you make long-term predictions in this situation? How can you organise your overseas business, whether you’re trading with foreign partners or managing distant franchises, when you don’t know what the exchange rates are going to do? In fact, there are some predictions you can work with where that’s concerned. This isn’t the first such uncertainty the international markets have experienced, and models exist that can take it into account. This article explains what the experts think will happen and what we can learn from events so far.

Different forms of Brexit

At this stage there are several directions that Brexit could take, each with its own probably consequences for the exchange rates:

• A fixed deal for a full exit – business likes certainty, so this kind of deal would have the advantage of letting everybody know where they stand. As many people have been waiting for a bit of certainty so they can undertake delayed transactions, this would be likely to result in a short-term rise in the value of the pound, but most experts think it would start to fall again thereafter.
• A Norway-style option – this kind of solution would also provide some stability and clarity, so the pound would be likely to rise in the short term. In the longer term experts think it would fall but its movement would be more closely related to that of the euro than in other scenarios, which should reduce uncertainty in that exchange.
• A deal allowing for further negotiation – this type of deal would help the markets to stabilise in the immediate term, potentially buoying the pound a little but not as much as in the scenarios above. In the longer term, because it would prolong uncertainty, it could be expected to keep the pound low.
• No deal – this would be by far the worst option where the pound is concerned; experts think it could fall by as much as 22% and that it would remain low for up to ten years.
• No Brexit – if Brexit is so chaotic, would things settle down if it were simply cancelled? Probably, but not immediately. There would still be a shock to the system with possible social unrest impacting infrastructure, and the pound would probably fall as a result. Its ability to recover would depend on whether or not the government said Article 50 might be activated again in the near future.

Key moments for traders

If you’re hoping to take advantage of currency shifts as a trader, when should you expect key movements to occur? The first would be expected at the point when a firm decision is made, even if that decision is that there will be no Brexit or that negotiations will continue after the end of March. The pound may rally briefly but will probably drop again within 48 hours. Brexit day itself is likely to result in a further significant drop, but because everybody will have anticipated that it will be difficult to secure much advantage from it. More interesting is the point at which positive movement in response to certainty tips into a steeper fall. Traders will have to watch the markets closely to try and spot this ahead of their competitors.

Over the next few months

As Brexit draws closer, it’s important to be aware that changes in the exchange rate won’t wait for it to happen. In fact, it has already had a significant effect on the productivity level and shape of the UK economy. This means that although the key moments described above matter, if you are planning to transfer currency internationally you can’t assume that you have until the end of March to avoid the impact of a low pound. Nevertheless, it’s expected to be early June before the pound begins to fall more steeply.

Over the next few years

Most experts predict that the pound will be depressed by around 6% to 12% for at least the next three years. Within that time, however, there will be the usual short-term fluctuations. Uncertainty around the Trump regime and the weaknesses now being exposed in the US economy could strengthen the pound against the dollar, and it’s almost certain to rally in response to the presidential election in 2020. Elsewhere, China’s ongoing economic instability may help it against the renminbi.

While Brexit may weaken the pound, other economies face other challenges, so there’s no simple map of the future. As always, the key factor to consider is market confidence. As the transition takes hold, this should grow again, allowing the pound to rise.

By Lee

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